Understanding how forex works
Currency trading, also known as FX trading, is the exchange of currencies between two parties at an agreed price. The trading parties may be financial institutions, multi-national corporations, banks, central banks, hedge funds, money changers, insurance companies, speculators, or individual traders.
Currency trading is done in pairs. A currency pair consists of a base and a quote currency – for example, the currency pair of EUR/USD consists of EUR, which represents the base currency, and USD which represents the quote currency. The exchange rate of EUR/USD at 1.1630 simply means that to own one euro, you need the equivalent of 1.1630 in US dollars.
The ultimate goal of FX trading is to identify the correct direction of the markets. It’s all about buying a financial instrument low and closing the position higher, or selling a financial instrument high and closing the position lower.
To begin, traders choose a trading platform to trade currencies on. There are many different trading platforms to choose from, including MetaTrader
The Basics of Currency Trading
Traders can now easily access the markets thanks to devices like smartphones, and as a result currency trading is becoming increasingly popular. The user-friendliness of trading platforms and the 24-hours/five-days-a-week trading schedule makes currency trading highly appealing. The markets’ high liquidity means traders can trade almost any volume at their desired price, and are not likely to experience price manipulation.
If that wasn’t enough, a daily turnover of about $5 trillion, the availability of leverage, and educational resources provided by some brokers attract a huge number of traders across the world.
There are many different strategies which are commonly used among traders:
The foreign exchange market allows two currencies to be exchanged, at an exchange rate which is floating or fixed. This allows businesses from around the world to complete transactions across currencies. Currencies need to be exchanged to import produce from different countries, for example: a wine merchant in England exchanges their pound sterling (GBP) for euros (EUR) in order to purchase wine from France. Exchanging currencies is the basis for all international trades. Unlike the stock market, the forex market is decentralised – this means that there is no central trading area. Most foreign exchange transactions are executed over-the-counter (OTC) by banks, on behalf of their clients.
Where did it start?
It all began with the gold standard monetary system back in 1875. Before our current system was born, gold and silver were exchanged for goods and services. The problem was that gold’s value changed depending on the supply – if a new source was discovered, gold would become less valuable. Eventually, different countries began to peg an amount of their currency to an ounce of gold. The difference between these amounts was an exchange rate. After World War One this system broke down, and several years later currencies were no longer pegged to gold.
FX trading used to be completed exclusively through banks and forex brokers. However, as technology has developed, FX trading has become far more accessible. Individual traders can now access the FX market from their smartphones, and complete trades on the go.
Today, the forex market is open 24 hours a day, 5 days a week. The first markets open on Monday morning in Wellington, New Zealand, and the last close at 5pm (ET) on Friday in New York.
Major Currency Pairs
All major currency pairs contain the US Dollar and are the most commonly traded FX pairs.
- EUR/USD Euro/US Dollar
- USD/JPY US Dollar/Japanese yen
- GBP/USD British pound/US Dollar
- USD/CHF US Dollar/Swiss franc
- USD/CAD US Dollar/Canadian Dollar
- AUD/USD Australian Dollar/US Dollar
- NZD/USD New Zealand Dollar/US Dollar
Cross Currency Pairs
Crosses are pairs that do not include the USD otherwise known as FX "crosses".
- AUD/CHF Australian Dollar/Swiss Franc
- AUD/JPY Australian Dollar/Japanese Yen
- CAD/CHF Canadian Dollar/Swiss Franc
- CAD/JPY Canadian Dollar/Japanese Yen
- CHF/JPY Swiss Franc/Japanese Yen
- EUR/AUD Euro/Australian Dollar
- EUR/CAD Euro/Canadian Dollar
- EUR/NZD Euro/New Zealand Dollar
- GBP/AUD Pound sterling/Australian Dollar
- GBP/CAD Pound sterling/Canadian Dollar
- GBP/CHF Pound sterling/Swiss Franc
- GBP/NZD Pound sterling/New Zealand Dollar
- NZD/CHF New Zealand Dollar/Swiss Franc
- NZD/JPY Japanese Yen/Japanese Yen
Exotic currency pairs
Currencies from emerging and developing economies, paired with a major currency.
- EUR/TRY Euro/Turkish Lira
- USD/TRY US Dollar/Turkish Lira
- USD/SEK US Dollar/Swedish Krona
- USD/NOK US Dollar/Norwegian Krone
- USD/DKK US Dollar/Danish Krone
- USD/ZAR US Dollar/South African Rand
- USD/HKD US Dollar/Hong Kong Dollar
- USD/SGD US Dollar/Singapore Dollar
- USD/THB US Dollar/Thailand Baht
- USD/MXN US Dollar/Mexican Peso
What are Forex Reserves?
Forex reserves are foreign currencies held by a central bank in order to grant greater flexibility and resilience. A reserve is any currency held by a financial authority which is centralised. The reserve assets can be used to endure market shocks if a particular currency becomes devalued or suddenly crashes. Higher foreign currency reserves ultimately mean lower risks associated with exchange rate fluctuations.
In a manual system, the trader actively looks for signals and interprets them to choose whether to buy or sell. In an automated system, the software identifies a signal and makes the programmed response.
What are Forex Signals?
Forex signals are trade forecasts usually issued by knowledgeable and experienced signal providers. The signals are based upon a series of technical analyses or news events, and are used by traders to help them decide whether they should buy or sell a currency pair. Day traders in particular may use a variety of forex signals to inform their next trade. Forex signal systems produce either manual or automated signals.
If that wasn’t enough, a daily turnover of about $5 trillion, the availability of leverage, and educational resources provided by some brokers attract a huge number of traders across the world.
There are many different strategies which are commonly used among traders:
What is Foreign Exchange?
Foreign exchange is the market where one currency is exchanged for another. It is always done in pairs; for example if a trader wants to buy Euro and sell the US Dollar, then he would be trading the EUR/USD currency pair. Similarly if a trader wants to sell the US Dollar and buy the Japanese Yen he would be trading the USD/JPY pair. The price of a currency pair is called the exchange rate. It is determined by political, economic and environmental factors.
Transactions in foreign exchange are usually conducted in high volumes. Foreign exchange market has no physical location and hence it is called a decentralised market. It is open 24 hours a day, 5 days a week and is the largest market in the world.
Geopolitical Events
These types of events have direct or indirect consequences, either worldwide or for a particular set of countries. Geopolitical events have great psychological and emotional consequences for the equity and currency markets.
A few examples of such events including:
Gross Domestic Product and Inflation
Gross domestic product (GDP) is a financial economic indicator which measures the total value of goods and services produced in a country, over a designated period of time.
The GDP is one of the most important indicators, and is used to evaluate a nation’s overall economic health. Construction costs, government outlays and investments all contribute to a country’s overall GDP. Inflation is an economic indicator that measures the increase of a country’s prices for major goods and services.
The rate at which prices are rising dictates the rate at which the purchasing power of the currency is falling. In order to maintain a smooth economy, central banks aim to limit inflation and avoid deflation.
Macroeconomic Indicators
These are fundamental indicators which directly or indirectly point towards a weak or strong economy. Macroeconomic indicators based on the Gross National Product (GNP) and the Gross Domestic Product (GDP) are used to estimate an economy’s efficiency.
This data is then released in reports which have major effects on a country’s currency. Aside from GNP and GDP, some of the major macroeconomics are:
A forex signal is a suggested entry or exit point for a forex trade, usually with a specific price and time indicated. Forex signals can be obtained from either specialist companies or a number of knowledgeable and experienced traders. The services may be free or come with a charge – most brokers offer their own forex signals either for free or for a low price.
Traders can view the performance results for any signal provider on a platform, and decide to accept or reject future trade recommendations into their trading accounts. Due to providers protecting their strategies, traders may have to blindly follow a signal provider.
Some brokers offer their own unique twists on forex signals, by merging the concept of forex signals with a number of technical tools into one grand forex trading system. Trustful Trading Signals is one such example.
Trading Signals
Developed by Trustful’s Head of Education, Andreas Thalassinos, Trustful Trading Signals provides traders a unique opportunity to use a tool for spotting trading opportunities in the market.
Features of Trustful Trading Signals include:
Demo Trading Accounts
Demo trading accounts are perfect for traders looking to establish the fundamentals and work on their technique. Beginning on a live account means that there’s the possibility of losing real money as you work out which technique works best for you.
Before moving on to a live trading account, it is a good idea to try out a few different approaches, and practice with a demo account. Demo accounts grant traders the opportunity to develop and test their trading skills, without facing the kind of risks you do on a live account.
Traders who want to iron out the creases in their trade before they hit the live markets have a range of demo accounts to choose from.
Live Trading Accounts
After you’ve refined your skills and experimented with different types of analysis and indicators on a demo account, it is time to switch to a Live Account and start trading with real money! Demo Accounts are great for practice, but Live Accounts offer all the real advantages of the FX markets.
Once traders are ready to move on to the live markets, having established a trading strategy which works for them, they can set up their first Live Account. Like Demo Accounts, there’s a huge range of options available for a trader looking to upgrade their trading from Demo to Live.
Forex Trading Software:
There are many FX trading platforms that a trader may choose from. Some of them have a monthly subscription, but most are available for free. Some popular forex trading platform providers include Zulutrader, Ninjatrader and TradingStation. Some of the most popular forex trading platforms are:
Metatrader 5
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Metatrader 4
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Different types of trading tools for technical analysis:
When it comes to finding the right tool for daily analysis, a trader has a wide range of technical analysis tools to choose from.
Popular indicators include: the moving average indicator, which filters out price fluctuations to help traders identify trend directions, and Bollinger Bands, which plot two lines, two standard deviations away from the moving average.
Oscillators based on statistical concepts are another common addition to the trader’s toolkit. Oscillators are used to estimate whether an asset is overbought or oversold. Popular oscillators include the RSI (Relative Strength Index), MACD (Moving Average Convergence/Divergence), Momentum, Stochastic and ADX (Average Directional Movement Index).
To identify turning points in the markets, and analyse chart patterns, FX traders commonly use support and resistance, along with Fibonacci retracement tools and Japanese Candlestick patterns.
Aside from these, other FX traders prefer to use chart patterns including head-and-shoulder, double top/double bottoms, and draw trend lines to identify trend patterns.