This is a series of articles about The Foreign Exchange Market. You will learn here what Forex is, how it works and how profitable it can be. The whole series contains the following articles . . .
- What is Forex
- Technical analysis
- Fundamental analysis
- Money management
- Compound interest
What is Forex?
The word Forex is an acronym for The Forex Exchange Market. This is the most liquid market on the world where you can trade or exchange one currency for another. For example, if you think that the Euro will appreciate in value and you have US dollars, you can trade the dollars for the Euros. If you are right and the Euros appreciates in value against the dollars, then you can trade the Euros back into Dollars realizing a profit.
This is the basic idea behind the Spot Forex Market. The Forex Market is an inter-bank system which means that it is not centralized. There is no central exchange where currencies are traded. It is a global market in which all the major banks in the world connect to each other to transact Forex. You can trade Forex online 24 hours per day, 6 days per week.
This market emerged in the early 70’s. The reason was that currencies where no longer backed up by gold. They began floating freely where their value depended on forces of supply and demand due to economic factors, speculation, etc. This is the origin of the Forex Market.
You can trade Forex on the Internet from where you have access to many online brokers like egm securities that allow you to open an account with just $200 to $500 and start trading online. You can also get a demo account first and trade with virtual money just to test out your knowledge and trading skills and see if you would like to further pursue trading.
Demo accounts are free with most brokers. Some brokers offer demo accounts which expire within a few weeks while others never expire. It is important to rewind and playback the markets and trade on paper, because you can test your strategies over weeks or months of data within a short period of time and see if they work or not.
Trading Forex is risky, but it can be very profitable too. You can trade with leverage of any amount up to about 400:1 which means 400 times the size of your account. This means that the broker will lend you more money than you have on the account to trade.
For example, let’s say that a broker allows you to trade at 100: 1 leverage. If you use all the leverage, for every dollar that you have on the account you can trade 100 times the value of your account. Let’s say that you have $1,000 in your account. With $1,000 at 100: 1 you can trade $100,000 worth of dollars in exchange for other currencies. You multiply your trading potential a lot. This allows you to realize bigger profits, but you also incur in bigger risks.
You can also lower your risk by selecting a smaller amount of the leverage provided to you. Leverage works like an overdraft facility, so just because you have a high limit that does not mean you should max out on your limit.
Let me show you an example. Let’s say that you have 100: 1 leverage on the account and you trade at full leverage with $1,000. The EUR/USD pair (Euro/US Dollar) is trading at 1.2500. So, you enter a position on this pair.
Let’s say that you buy 100,000 Euros. If the market moves in your favour by just one cent (1.2600), you will double your money and end up with $2,000 on the account. If the market moves against you by just one cent (1.2400), you will lose all the money that you have on the account or most of it depending on the broker you are trading with.
This is what makes Forex very profitable, but also very volatile. I don’t know if novice traders can understand the magnitude of what I am saying here. Many people get into Forex trading only seeing half of the truth. They get pulled into this market by all the hype flying around it.
I do believe that no other market in the world offer the opportunity to make money like this market does. On the other hand, there are some risks involved. It is important for new traders to trade on demo/virtual accounts first before compromising real capital. We learn through practicing. You start to learn many basic concepts about this market when trading with a demo account.
Now, let me explain other important facts. The Spot Forex Market is traded in currency pairs. Whenever you enter a position you trade one currency for another. For example, if you buy EUR/USD you are buying Euros and selling US Dollars. If you sell EUR/USD you are selling Euros and buying US Dollars.
When you enter a position with full leverage, you cannot trade other currency pairs unless you have additional funds on your account, but you can trade several currency pairs at the same time as long as you have enough margin/funds to trade by using just a portion of the leverage available to you . If you have never traded Forex before, you can see how all this works when you practice with a demo account.
Another thing that you would like to know is that Forex is traded in pips. Your profit on every trade depends on many aspects. One of those aspects are pips. Another one is how much leverage you are using per trade. A pip is the minimum unit that the price of a currency pair can move.
For example, in the case of the EUR/USD a pip is equal to 0.0001. If the price is at 1.2500 and it moves to 1.2501, then it has moved one pip. If it moves from 1.2500 to 1.2600 it moves 100 pips, like in the example above.
Now, how much you make on every trade depends on how many pips you make and how much money you invested on that trade. Also, what is the leverage for that account. If you trade at full leverage with a 100: 1 leverage account and you trade $1,000, if the market moves 50 pips in your favor, then you will make $500. This can happen within just a few hours after you enter your order.
Most experienced traders wouldn’t recommend you to trade this way though. The reason is that if the market moves against you, then you could lose everything within hours. It is better to have lower profit goals for every single trade and compound your profits over time.
Money management principles state that it is better to never risk more than 1% – 3% of your capital on any given trade, especially if you are an inexperienced trader. This is something that I will explain more under other article of this series.
Well, I hope this information have been helpful to you. This was an introduction to the Forex Market.
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