What is forex trading? Is it similar to stock trading? Forex or Foreign Exchange Market is the market where the transaction of buying and selling currencies all around the world takes place. It is similar to stock market trading. The difference is merely on the transacted product. Forex is an OTC market (Over the Counter). Therefore, you are able to trade various currencies meta trader 5 available around the globe. Forex trading is now considered as the most liquid financial market that operates 24 hours nonstop. CFTC (Commodity Futures Trading Commission determines the regulation in the forex market, but the regulation is considerably the loose one. On the other hand, there are also other regulations for retails brokers as well as market traders that are authorized by NFA or National Futures Association.
To understand how forex market works, first, you have to know the terminology used in the forex trading. Here are some basic terms that you will always encounter during the transaction.
1. Cross Rate
You will find that the currencies traded in forex are always in pairs, for example 1.4582 EUR/USD. You should read these pairs as USD $1 is equal to EUR 1.4582. You can see that US dollar in this currency pairs is not the exchange rate being determined, but the EUR is. The EUR that serves the referred exchange rate is known as the cross rate.
2. PIP
PIP is the abbreviation of Percentage in Point. It is the smallest price unit in a currency movement. PIP holds a crucial role in forex trading, because it determines how much profits you have gotten. There is certain pip measurement, for example, 1 pip is equal to.001 for EUR/USD currency pair. It means that 1% increase in EUR/USD will take 100 pips increasing movement.
3. Bid-Ask Spread
The bid is the figure representing the cost price of the dealer and the ask is representing the selling price of the dealer. They are always quoted in pairs and the difference between bid and ask is known as the spread. When you see a figure such as.709560-56 EUR/USD, the bid price refers to.709560 and the ask price refers to.709556. The market makers determine the bid-ask quotation and they can generate profits from the bid-ask difference or spread.
After knowing the terminology, you also have to know the participants in the forex trading and their reasons of doing it. Here are the participants involved in the trading:
1. Government and banks
Governments and central banks from countries all around the world will be one of the main players in the forex market. They are into the trading for maintaining their forex reserves. There are times when government decision is related to the BOP (balance of payment) purpose. When the government wants to increase the export volume, it is likely that they will sell their currency in order to increase their currency supply. By doing so, there will be a currency depreciation that leads to exports increase. Every decision taken by government or central bank can significantly influence the forex market influence because of their large-scale authorities.
2. Business firms
Business firms will generally take part into forex trading when they need to do the hedging. The hedging is the action to lock in a particular favorable currency rate in a certain currency pairs. For example, there is a U.S based firm, which supply wheat to Europe countries. The payment as agreed will be in EUR. If there is any EUR depreciation, this U.S based firm will only get fewer dollars with Euros. Therefore, the hedging can be done to protect the favorable rate between Euro and US dollar. Otherwise, the U.S firm based might greatly suffer from the EUR depreciation impact.
3. Banks and Financial Institutions
The other parties involved in forex trading are banks and financial institution. They mainly involve in the interbank market segment in which the profit can be generated from the bid-ask spread. Every bank has credit relations to other bank. In the interbank market, every involved bank will have its own determined credit relation and importance. The measurement of this standard will be based on the monetary size of the involved bank.
4. Hedge Funds
The role of hedge funds here can be seen if there is particular party who is trying to predict the market direction. They intend to get profit from the sales itself. Therefore, their main purpose is to buy low and sell high.
5. Retail Forex Brokers
These days, you can find many retail forex brokers in Internet. Through these retail brokers, individuals with small capital have the opportunity to join the forex trading and generate profit. People can make accounts in brokers’ platforms and start forex trading. Many online retail brokers have policies to allow margin trade in which for example, people with $1 account are allowed to trade up to $100. Therefore, people do not need to provide bigger account to have bigger transaction when such margin trade is allowed. Online brokers usually provide the traders with demo accounts so that the traders can try out the offered platform first. Besides that, the broker will also provide some other supportive tools to help you in trading, such as tutorial e-book, news bulletins, technical analysis tools, charts, automatic buying or selling signals and some others. Since there are many online retail Forex brokers, you must be extra careful in determining which one to join because there are many scammers. Looking for a regulated broker is the main key to pay attention before jumping to the online forex trading.
Even though you might get a great fortune and profit from online forex trading, you also need to be careful and always remember that online forex trading is a high-risk business too. You can earn high profit as well as lose much in the online forex trading. Therefore, you must equipped yourself with sufficient forex trading knowledge, try to find and select the best retail forex broker with an appropriate platform before you decide to jump in the forex trading market.