Forex trading entails purchasing and selling currency pairs. The value of any given pair depends on whether you expect one currency will appreciate against another currency pair, or depreciate against it.
Forex trading involves purchasing and selling currency pairs in lots of 100,000 units each. A pip, the smallest unit of measurement used on the forex market, serves to indicate price changes on this currency exchange market.
Forex trading can be an efficient and lucrative way to earn extra income, but it comes with risk. Beginners should familiarize themselves with how currency trading works and be wary of potential pitfalls before jumping in.
The foreign exchange market, commonly referred to as forex market, is an international decentralized exchange for trading currencies that determines exchange rates and offers all aspects of buying, selling and exchanging at current or predetermined prices. By trading volume alone it represents one of the world’s largest markets.
Currencies are traded in pairs, with each pair consisting of a base currency and quote currency. Their value is determined by how much quote currency it takes to purchase one unit of their base currency.
Understanding Currency Pairs
Forex (or Foreign Exchange Market) is an international decentralized marketplace where traders trade currencies. Currencies are traded in pairs; when purchasing one currency against another. When purchasing currency pairs, traders are buying the base currency while selling the quote currency.
There are hundreds of currency pairs traded in the market, but seven major ones represent most trading activity – the EUR/USD, USD/JPY, GBP/USD, AUD/USD, NZD/USD and USD/CHF pairs.
Order is important when it comes to listing currencies because standards govern which one comes first and which follows it. This enables traders to understand price movements caused by events like economic news and other forms of information.
Using Fundamental Analysis
As many factors affect currency prices, it can be challenging for traders to remain abreast of them all. That is why fundamental analysis is so essential.
Economic analysis involves in-depth examination of a nation’s economy and political situation. A trader might, for example, compare interest rate data among various countries to gain a deeper insight into how these impact one another.
Example: A nation with higher interest rates could see its currency become stronger due to increased money supply in that nation and increasing demand for it, thus strengthening it further and thus raising any assets held within it. That is why currency markets play such an integral part of global economies by providing businesses and governments with diversifying investments opportunities.
Using Technical Analysis
Technical analysis is an effective trading methodology often utilized when trading currencies. This type of analysis utilizes chart patterns and indicators to predict future price movements, under the premise that markets always move in repeating patterns that can be identified through studying trading charts.
Fundamental analysis differs in that it assumes supply and demand determine currency prices; when demand outpaces supply, its price should increase; conversely when supply outstrips demand, its price should decrease. Key drivers of fundamental analysis include economic growth, inflation and employment figures that are published frequently and can have an enormous effect on currency prices; also decisions by central banks can have an enormous effect on these figures.
Leverage can be an invaluable asset when trading currencies, providing the chance to take advantage of relatively minor price movements and diversify your portfolio with increased exposure while stretching capital further. But to use it effectively and keep risks under control it must first be understood how and when leverage works.
Leverage gives traders greater purchasing power in the forex market by only contributing a small fraction of total trade value, known as margin. While this increases profits and can accelerate losses, more information on leverage and margin in forex trading can be found by reading our guide to leverage and margin in forex.