What is Forex (FX)
How does Forex Trading Operates?
Forex trading entails simultaneous buying and selling of currencies. Traders analyze market trends to forecast currency price movements, aiming to profit from these fluctuations. Unlike traditional exchanges, forex trading occurs electronically across global computer networks. The market operates continuously, 24 hours a day, five days a week.
Forex trading includes the simultaneous purchase and sale of two currencies. For instance, when buying the EUR/JPY pair, you acquire EUR while selling JPY. Conversely, selling the pair involves purchasing JPY while selling EUR.
Technological advancements have enabled investors to access the foreign exchange market through online brokers, utilizing platforms like MetaTrader 4, MetaTrader 5, Iress, cTrader, and TradingView. For further details, explore How Do I Trade Forex?
The growth of online trading has facilitated the adoption of CFD trading. These leveraged products enable traders to open positions with an initial investment that represents only a fraction of the full trade value.
How Do Forex Markets Work?
Forex stands as the most widely traded over-the-counter (OTC) market, where currencies are bought and sold among a network of banks. Because there is no centralized exchange, forex trading operates in a decentralized manner, allowing for continuous trading 24 hours a day. The market is divided into four primary trading sessions.
The spot forex market is the predominant type in forex trading. Spot trades involve the electronic exchange of currency pairs through online trading platforms. Additional types of forex markets include the forward forex market and futures forex market.
Please bear in mind that timing adjustments for daylight saving occur in certain countries like Australia, the US, and the UK during October/November and March/April. It's important to plan your trades accordingly. The liquidity of currency pairs in forex trading varies with different trading sessions. For example, the EUR/USD pair experiences significant movement and liquidity during the overlap of the London and New York sessions, while the AUD/USD pair shows the most activity during the Tokyo and London sessions. Once you've determined the best times to trade, the next step is familiarizing yourself with the terminology. Here are some key terms and concepts you'll encounter in the market.
What is a Base and Quote Currency in Forex?
Major currencies are identified by their three-letter ISO codes. Examples include USD for the US dollar, AUD for the Australian dollar, EUR for the Euro, JPY for the Japanese yen, and GBP for the British Pound.
In forex trading, currencies are quoted in pairs. The first currency in the pair is known as the base currency, while the second currency is called the quote currency or counter currency. For example, if the EUR/AUD currency pair is trading at 1.6163, it means that 1 unit of Euro can be bought for $1.6163 Australian dollars.
Factors of Influencing the Forex Market?
Several factors influence the forex market, categorized into market participants and macroeconomic factors.
Market Participants
Super Banks: Due to its decentralized nature, the exchange rate in the forex market is largely influenced by the world's largest banks. Global financial institutions such as Barclays, HSBC, Citi, JPMorgan, and Deutsche Bank are prominent participants in forex trading.
International Companies: Large multinational corporations participate in the foreign exchange market to facilitate their business operations. For example, an Australian company selling products in the United States would need to exchange USD for AUD to repatriate their earnings back to Australia.
Retail Traders: These are individuals who trade their own capital with the goal of making a profit. Increased accessibility to the forex market via online brokers and sophisticated trading platforms has led to a rising number of retail traders participating in the forex market.
Economic & Macroeconomic Factors
Central Banks: Macroeconomic indicators like inflation play a crucial role in influencing forex markets. Governments and central banks, such as the Federal Reserve, convene regularly to assess their economies, determine interest rates, and implement monetary policies, all of which directly affect forex markets.
Capital Markets: The prices of stocks, bonds, and commodity futures can also impact foreign exchange markets.
International Trade: Trade figures of a country affect currency values in the forex market. Price movements in forex reflect trade deficits and surpluses.
Politics: This is especially true during significant political events such as elections, which often result in heightened volatility in the forex market. Examples include historical events like Brexit in the United Kingdom and various presidential election campaigns in the United States.
Here's how to begin with Forex Trading?
Review these 4 steps for initiating Forex trading:
Step 1 Educate yourself
Step 1 |
Educate yourself
Gain a comprehensive understanding of the market. Explore the benefits of forex trading for your situation and determine the time you can commit to it. Acquire skills in interpreting market fundamentals and analyzing charts.
Step 2 Find a Regulated Broker
Step 2 |
Find a Regulated Broker
A regulated or licensed broker ensures a level of protection and equips you with essential tools for efficient trading. Start a demo account with CapitalzFX to access our educational resources and practice strategies with real-time market pricing, all without risking your capital.
Step 3 Open a Margin Account
Step 3 |
Open a Margin Account
Determine your risk/reward preferences. Assess how much capital you can afford to risk in trading. Select an appropriate leverage based on this assessment; starting with lower leverage is advisable for beginners..
Step 4 Choose Trading Platform
Step 4 | Choose Your Trading
Platform
Australian licensed brokers provide top-notch forex technologies essential for long-term trading success. Swift trade execution, minimal slippage, secure funds, and effective technical analysis are crucial factors. Opt for a platform such as MT4 or MT5 that incorporates these features and supports trading on mobile devices.
A concise overview of the history of Forex.
Currency exchange traces its origins back to 600 BC with the introduction of the first official currency. Today, the forex market has evolved into the world's largest financial market. The following timeline marks significant milestones in the history of forex.
600
BC
The Kingdom of Lydia introduces coins crafted from gold and silver.
During the Tang dynasty in China, the paper note was invented.
618
AD
1661
AD
Sweden produces the first banknote ever printed in Europe.
Amsterdam establishes the world's first forex market.
17th
century
1819
AD
England implemented the gold standard, where the government pledged to exchange paper money for its equivalent value in gold. The United States adopted this standard in 1834, followed by other significant nations like France and Germany in 1870.
After several World Wars, the gold standard system collapses, leading to the establishment of the Bretton Woods System. During this transition, the US Dollar becomes the global reserve currency.
1946
AD
1973
AD
The official transition to the free-floating exchange rate system.
Emergence of online brokers
1996
AD
2005
AD
MetaTrader 4, a groundbreaking trading platform tailored for forex traders, is launched, offering real-time pricing capabilities.
The daily forex trading volume surpasses $5 trillion.
Today
Forex Quotes / Exchange Rates
Currencies are traded in pairs, such as EUR/USD (Euro/US Dollar) or AUD/USD (Australian Dollar/US Dollar). Each currency is identified by a three-letter ISO code, like EUR (Euro), GBP (Great British Pound), and USD (US Dollar). In a currency pair quote, the first currency is the base currency, and the second currency is the quote currency or counter currency. For example, if the EUR/USD pair is trading at 1.1086, it means you need $1.1086 to buy 1 unit of Euro.
The ask rate, which is higher at $1.1087, represents the price sellers are willing to accept for the currency. Conversely, the bid rate, lower at $1.1086, is the price buyers are willing to pay. These rates fluctuate continuously based on factors such as supply and demand dynamics, market sentiment, and external events.
Spread
The spread, which includes the broker's fees, represents the difference between the bid and ask rates. The size of the spread varies depending on the currency pair and the specific forex broker chosen. Licensed forex brokers offering ECN (Electronic Communications Network) pricing can access quotes from multiple liquidity providers in the market, allowing them to offer the most competitive spreads.
Begin Forex Trading with a Multi-Regulated Brand
An Example of Leverage CFD Trading
Imagine you are interested in trading CFDs based on the AUD/USD currency pair, often referred to as the "Aussie." Suppose the current trading price of the AUD/USD pair is::
In trading, the "bid" represents the selling price, which is the rate at which you sell the asset. Conversely, the "ask price" is the buying price, the rate at which you purchase the asset. The difference between these two prices is known as the "spread," which constitutes your trading cost. The liquidity of the asset and your chosen broker influence whether the spread is narrow or wide. Brokers who access quotes from a diverse range of liquidity providers can offer tighter bid/ask spreads to traders.
You opt to purchase AUD 20,000 worth of USD with the expectation that the AUD/USD price will appreciate. With a leverage ratio of 100:1, you are required to deposit 1% of the total position value into your margin account.
If within the next hour the price shifts to 0.6880/0.6882, you have a profitable trade. You have the option to close your position by selling at the current price of USD 0.6880.
In this scenario, the price moved favorably in your direction. However, if the price had instead decreased, going against your forecast, you might have incurred a loss. If this loss caused your account equity to drop below the required margin level, your broker could issue a margin call.
Notice how even a slight price fluctuation presents trading opportunities? This minor change is referred to as a "pip" or "percentage in point." In the forex market, as illustrated in the previous example, a pip denotes the smallest price movement in a currency pair. For pairs involving the US Dollar, such as AUD/USD, a pip is typically indicated up to the fourth decimal place. However, for pairs including the Japanese Yen, like AUD/JPY, quotes are typically displayed up to three decimal places.
This ongoing assessment of price fluctuations results in daily profit or loss calculations. These outcomes determine the net return on your initial margin, which can be positive or negative. If your initial margin falls below a certain level, your broker may issue a margin call. Failure to add funds may lead to the contract being closed at the prevailing market rate. This process is referred to as "marking to market."
What is Pip in Forex?
Pip is an acronym for Point in Percentage. It represents the smallest amount of change in the rate of a currency pair and is a standardised unit. For a US Dollar based currency pair, like the AUD/USD, one pip is $0.0001. However, for some currencies, like the Japanese Yen (JPY), it is denoted as $0.001.
Pip value fluctuations have an effect on trading gains. For example, if you decide to buy €10,000 and the EUR/USD pair is trading at 1.1086, the price you will have to pay will be $(10,000x1.1086) or $11,086.
If the exchange rate for this pair sees a 5-pip increase, which means the EUR/USD is now trading at 1.1091, then to buy €10,000, you will have to pay $11,091.
Forex Majors, Minors and Exotics
Not all currency pairs are traded in large volumes. The US Dollar, being the world’s reserve currency, is definitely traded the most; although, over the years, its dominance has waned somewhat. Based on how frequently they are traded, currency pairs are segregated into major, minor and exotic categories.
Majors
Major currency pairs have the tightest spreads.
They are:
EUR/USD
Euro/US Dollar (aka Fiber)
GBP/USD
British Pound/US Dollar (aka Cable)
USD/JPY
US Dollar/Japanese Yen (aka Ninja)
USD/CHF
US Dollar/Swiss Franc (aka Swissy)
CAD/USD
Canadian Dollar/US Dollar (aka Loonie)
AUD/USD
Australian Dollar/US Dollar (aka Aussie)
NZD/USD
New Zealand Dollar/US Dollar (aka Kiwi)
Minors
Then comes a category of minor currency pairs, otherwise known as cross-currency pairs. They are called so because they do not include the US Dollar. So, to convert one into the other, the US Dollar will need to act as a mediating currency.
A few of the minor pairs are:
EUR/GBP
Euro/British Pound (aka Chunnel)
EUR/AUD
Euro/Australian Dollar
CHF/JPY
Swiss Franc/Japanese Yen
GBP/JPY
British Pound/Japanese Yen (aka Gopher)
GBP/CAD
British Pound/Canadian Dollar.
Exotics
Exotics can include a major currency with an emerging market currency. Trading in exotics is considered risky, since they tend to have low liquidity, wider spreads and political instabilities in these countries can make these currencies volatile.
Some examples are:
EUR/TRY
Euro/Turkish Lira
USD/HKD
US Dollar/Hong Kong Dollar
AUD/MXN
Australian Dollar/Mexican Peso
In the brackets are the common nicknames for these currency pairs.
Going Long or Going Short
When you assume a long position in a currency pair, you buy a currency in the hopes that its price will rise (appreciate) in the future. This means you wish to buy the base currency and sell the quote currency, since you expect the base currency to appreciate with respect to the quote currency.
When you assume a short position in a currency pair, you sell the base currency, expecting it to depreciate (decline in price) in the future, allowing you to buy it at a later date but at a lower price.
Lot Sizes
When you decide on your position size, a term you will hear is “lot.” Lots are standardised position sizes for currencies. The forex market gives you the flexibility to trade according to your means and risk profile. The standard size for a lot is 100,000 units of the base currency. There also are mini and micro lot sizes that contain 10,000 and 1,000 units of the base currency, respectively.
What is Liquidity in Forex Trading?
Liquidity in the forex market refers to the ability of a currency to be bought or sold on demand. When you trade in major currency pairs, there are a lot of buyers and sellers in the market. This means that there is always likely to be an opposite player for every position you take. You can buy or sell large amounts of these currencies without causing any significant difference to the exchange rate.
Liquidity fluctuates during trading sessions. You are likely to see significant activity during the overlapping of the New York and London sessions. Depending on your style of trading, you could benefit from choosing specific trading sessions. For instance, short term traders prefer the US or London sessions, when large price breakouts and percentile movements tend to occur. The Tokyo session is often range-bound, which might not be the best for them.
Liquid markets, such as forex, tend to fluctuate by smaller increments, since high liquidity means less volatility. However, high volatility can occur due to significant external events.
The Concept of Leverage in Forex Trading
Leverage in forex trading is a useful financial tool. It allows traders to gain greater exposure to market movements than they could otherwise afford. So, this means a trader can enter a position worth $100,000 with just $1,000 in their account, with a 100:1 leverage ratio.
The leverage amount is provided by the forex broker. Consider it as a loan, which can help you to increase your gains with little price increments. However, also remember that leverage magnifies your losses too, if prices move in the wrong direction. This is why, it is important to put in place robust risk management strategies while trading.
When you decide to trade, you need to open a margin account with a regulated broker. Here, you will need to deposit an initial margin amount that is required to keep your leveraged positions running.
This is also called deposit margin. When the amount drops below the minimum level, your broker will issue a margin call. This means that you need to deposit funds to keep your positions open. Otherwise, the broker may close your positions.
A 50:1 leverage ratio means a minimum margin requirement of 1/50 or 2% of the total trade value from you. Similarly, a 100:1 leverage ratio means that you need to deposit at least 1% of the total value of your trade in your margin account.
Technical and Fundamental Analysis
Using guesswork to predict the direction of price movement is not the best idea. Experienced traders carefully conduct market analysis, in order to determine the direction in which currency rates are likely to move. Two major approaches are used here: fundamental analysis and technical analysis.
Fundamental Analysis
Currency values fluctuate according to a nation’s perceived economic health. Fundamental analysis is the study of all factors that impact a country’s economy and is also representative of its future trends. When investors perceive a particular economy as being more rewarding than others, demand for the domestic currency increases, driving up its price. Fundamental traders look out for these indicators to gauge the economic health of a country.
Monetary Policy: The interest rates decided by a country’s central bank directly impact the domestic currency. When the interest rate increases, currency value tends to appreciate and vice versa.
Inflation Rate: Central banks are responsible for keeping inflation in check and promoting employment. To do so, they have various tools available, including the nation’s monetary policy, market interventions and quantitative easing.
Balance of Trade: The balance between a country’s exports and imports can impact currency values.
GDP Growth: The overall health of an economy is denoted by its GDP growth. Currency values tend to appreciate with a favourable GDP growth rate.
There are several other economic indicators, like employment rate, retail sales, manufacturing index and housing market data, that impact the forex market. To keep track of the economic releases, traders use an economic calendar. This is because significant volatility tends to ensue on the days that important reports are released. Based on whether the actual figures meet or beat market consensus, currency prices can go up or down.
Technical Analysis
Technical analysis is based on the principle that the markets tend to repeat their historical price trends. To discover these trends, traders rely on technical indicators and forex chart analysis. Technical indicators are actually statistical formulae that can provide important information about the market. They are categorised into:
Trend: Such as Simple Average, Trend lines, Moving Average Convergence Divergence (MACD)
Volume: Such as On Balance Volume (OBV), Chaikin Money Flow
Momentum: Such as Stochastic Oscillators, Relative Strength Index (RSI)
Volatility: Such as Average True Range (ATR), Volatility Index (VIX)
Forex trading platforms like MetaTrader 4, MetaTrader 5, cTrader and TradingView come with pre-installed technical indicators, allowing you to analyse the ongoing trends and any chances of price reversals. Based on these indicators, you can create forex trading strategies.
These platforms also allow you to use a combination of both fundamental and technical analysis. While fundamental analysis, through financial news alerts, allows traders to gauge the interest rate and inflation outlook for both currencies in a pair, technical indicators and charts provide insight into trends and ranges within the price history. Chart patterns can provide clues regarding how prices might move within the patterns and where they are likely to go after a break-out.
Frequently Asked Questions
The main difference between the two is that Forex is limit to currencies while Contracts for Difference (CFDs) cover a broader range of asset classes. This includes Shares, Indices, Commodities and Cryptocurrencies.
Similarities and Differences Between Forex and CFDs
This depends on a number of factors including the currency you wish to trade, any time constraints and trading strategies. It is important to note that the forex market is most active when major trading sessions overlap. For further details about forex trading hours and the most actively traded currencies, Click Here.
MetaTrader 4 is the world's most popular trading platform. Specifically designed for forex trading, it has an array of features and tools that help provide an exceptional trading experience. Those who are looking for a more elaborate platform can consider MetaTrader 5. Read Top Forex Trading Platforms to help decide which is best for you.
Algorithmic trading is trading based on an algorithm or set of computer programs that include a specific set of rules to execute market orders such as stop-loss orders. Expert Advisors (EAs) and copy trading software such as AutoTrade are examples of algorithmic trading. Learn more about Algorithmic Trading.
International and local financial regulatory bodies and agencies, including the Financial Stability Board (FSB), the European Securities and Market Authority (ESMA), the Islamic Financial Services Board (IFSB), the Financial Conduct Authority (FCA), the Australian Securities and Investments Commission (ASIC), and the Cyprus Securities and Exchange Commission (CySEC) set prudential standards, regulations and guiding principles for the effective and sound supervision of the financial industry and the forex market to ensure investor protection and successful development of the securities market. A forex broker must comply with all set standards under the jurisdictions it is registered or licensed and must undergo regular audits.
Forex Rates and Currency values fluctuate according to a nation’s perceived economic health. The main factors representing a country’s or union’s economy are:
The fundamental differences between the forex market and the stock market are that in foreign exchange, traders buy and sell single or multiple currencies, aiming to seize any of the countless occasions of the topmost liquidity and high volatility the forex market offers. The stock market is the meeting point of investors trading stocks (shareholder equity) of publicly traded companies, mostly as short-term, mid-term investments and portfolio diversification. Stock trading requires more capital and in-depth technical analysis. Trading stocks is considered currying reduced risks and being less volatile than forex trading, mainly due to an economy’s slower and indirect effect on a company’s performance.
Trading forex requires less capital than other investments. Having a proper plan and sticking to it is essential for maintaining discipline and implementing good real-time risk management strategies even with a minimum of A$100. Set your financial targets and open a Demo Account or Live Account with a broker who offers robust education, support and soundness. Learn, sharpen your trading skills and design your trading strategies for a more prudential trading experience.
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