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If you are looking to expand your buying and trading in the financial markets, you should look into opening a forex account.
In 2019, the Bank for International Settlement (BIS) reviews show the global forex market experiences a trading volume of $6.6 trillion. The United States dollar holds a dominant currency status and is on one side of 88% of all forex trades.
Who wouldn’t want to trade in the largest financial market in the world? The global forex industry value is $1.93545 quadrillion. It has a turnover that is 53 times more than the New York Stock Exchange.
High-level currency trading is more difficult than it sounds, and many traders suffer loss. Let’s take a look at what forex is and what you need to know to start trading in foreign exchange accounts.
What Is Forex (FX)?
Forex (FX) is an open market where national currencies trade 24 hours a day, five days a week. Trades are not conducted on holidays or weekends.
Investors, retailers, and financial institutions speculate on which currency will increase or decrease in value. They then buy and sell currency using the network. The method for calculating profit and loss is to look at the difference between the price of the currency purchased and what it is later sold at.
In simple terms, you open an account for trading foreign currency. You deposit money into your account and use it when buying and trading. You do need to understand pricing, trading, and risks.
How Pricing Works
Foreign currency trades in pairs using country abbreviations. To know what you are buying and selling you need to know international currencies and codes.
The first currency listed in a forex pair is the base currency. The second is the quote currency.
There is a price related to each currency pair. The price is how much one unit of the base currency is worth in the quote currency. Here is how it works:
USD/CAD = U.S. Dollar [base currency] v. Canadian Dollar [quote currency]
The price of a forex pair is based on the value of one unit of the base currency in the quote currency. If the price listed with this pair is 1.2569, that means it costs 1.2569 Canadian dollars to purchase one U.S. dollar.
If the price on that same pair changes to 1.3336, it will then cost 1.3336 Canadian dollars to purchase one U.S. dollar. In other words, the U.S. dollar has increased in value and the Canadian dollar has decreased in value. The result is it now costs more Canadian funds to purchase each U.S. dollar.
Speculation leads to decisions on purchasing and buying render the greatest profit. If you believe that the base currency in a pair will gain in value against the quote currency, you make the purchase. The term for this is going long.
On the other side, if you believe the base currency is going to lose value in the market, you can sell the pair. The term for this is going short.
Traders buy foreign currency in blocks, also called lots, of currency. Lots sell in three size specifications:
- Micro Lot = 1,000 worth of a given currency
- Mini Lot = 10,000 worth of a given currency
- Standard Lot = 100,000 of a given currency
You are able to trade as many blocks as you want at a time. You might decide to trade 30 micro lots (30,000), or 2 mini lots (20,000), or 50 standard lots (5,000,000).
Currency is always traded in relation to another currency. Every time you sell one currency you purchase another. Every time you purchase one currency, you sell another.
The buying and selling are all handled electronically. There is no physical exchange of currency.
Conducting a Transaction
A trader may believe that a foreign currency will increase in value against the U.S. dollar. The trader purchases the foreign currency based on that speculation.
If later in the day the price of that bundle increases, the trader has made a profit. If the price of the bundle decreases, the trader has a loss.
The trader may decide to roll over their position overnight. The interest rate differential will determine whether the trader incurs a profit or loss on the transaction.
If the foreign currency the trader purchased has an interest rate of 4% and the U.S. currency has an interest rate of 3%, the trader has a higher currency interest rate because they purchased the foreign currency.
This means at rollover the trader will receive a credit. If the foreign currency interest rate is lower than that of the U.S. dollar, the trader will receive a debit at rollover.
Different interest rates have a huge impact on credits earned or decreased profit. In the United States, many brokers give leverage of up to 50:1. This eases the out-of-pocket expenses a trader needs.
If a broker offers a 10:1 leverage, a trader can trade $5,000 worth of currency if they have $500 in their account. If the leverage was 20:1 they would only need $250 to conduct the transaction.
If the trader’s speculation was correct, it is an easy way to turn profits without a significant cash outlay. On the flip side, if the trade goes the other way and they experience loss, a trader can quickly lose all or more than their capital outlay.
Forex (FX) Rollovers
A rollover means that the broker is resetting the positions and will provide a credit or debit for the difference in the interest rates of the two currencies in the pair being rolled over. The trade proceeds but the trader will not deliver or settle the transaction.
Once the trade has closed the trader’s profit or loss is determined based on the original transaction price and the price the trade closed at. The credits or debits from the rollover will add or subtract funds.
A forward transaction is a custom arrangement to buy or sell a designated amount of currency for a specific price. The contract states the settlement date and price. The settlement date is the exchange takes place.
Pricing is based on an adjustment to the spot rate. This allows for the interest rate differential between currencies. The adjustment is referred to as forward points.
The interest rate difference is the only thing reflected by the forward points. The points do not in any way estimate future spot market trading.
A forex future occurs when two parties agree to a trade for a specific amount of currency on an established date, also referred to as an expiry. The terms of this contract are not negotiable.
The difference between the prices of the buying and selling of the contract determines the profit. Future contracts are not held until they expire because the trader will then be obligated to settle and deliver the currency in the contract.
Currency pairs move in cycles, then consolidate. The ongoing cycles and consolidations create recognizable patterns. Traders read forex chart patterns to determine the trend direction of currency.
Forex chart patterns include the entries, stops, and profit targets in a pattern that can be easily seen. This pattern gives insight into trend reversal and the potential of participating in the trend with a defined entry and stop level.
Why Forex Exceeds Other Markets
There are no central bodies or clearinghouses overseeing the forex market. With fewer rules, the investors are not held to strict regulations found in the stock market
With an open market 24 hours a day, 5 days a week there is no cut-off on trading. Forex trading centers are in 4 different time zones around the globe, with locations in Tokyo, New York, Sydney, and London.
With an unregulated market, brokers are able to charge varied commissions and fees. Some forex brokers mark up the spread on currency pairs. Other brokers charge a fluctuating commission based on how much currency is in the trade.
In the United States, you can leverage up to 50:1 when purchasing on the forex market. With an account holding only $1,000 a trader can buy or sell up to $50,000 in currency.
Understand the Risk
Trading in foreign currency carries more risk than the stock market. When trading in an unregulated market you must look into the reputation of any broker you intend to use. Avoid fraudulent brokers by only opening accounts with U.S. brokers
The broker you select should be a member of the National Futures Association. Use their Background Affiliation Information Center to confirm you are using a legitimate brokerage center with a strong compliance record.
In addition to a reputable broker, you need to know your own risk level. Consider your maximum profit and loss risk you can take before engaging in a trade.
It is easy to jump into leverage trading because you don’t have to pay in full upfront. This is a great way to maximize profits. It is also an easy way to compile losses that exceed your capital account.
How to Open a Forex Account
It is easy to open a forex account. Forex trading is managed by brokerage, so you will need to find a forex broker.
You complete a questionnaire to determine your trading intentions and knowledge. You will verify your identity and make a deposit into your forex account. Upon completion of these steps, you will be able to start trading.
If you enjoy trying to determine what the markets are going to do based on speculation you will enjoy forex account trading.
We invite you to check out our other blogs where you will find more engaging information.