Forex Trading: A Beginnner’s Guide to Higher Profits

Forex trading – What does it entail? Well, every country in the world has a local currency that’s used by its citizens and residents when carrying out business transactions. In order to trade with people in other countries, it is necessary to exchange local currencies with foreign ones. For example, a Germany resident who wants to buy computers from the US must exchange the Euro for the dollar. This is also true for travelers to other countries. It is necessary to get an equivalent of the local currency in order to make transactions.
Forex Trading
Forex trading involves buying and selling currency
It’s the need for currency exchange that has necessitated the existence of the forex market. Also known as currency trading, FX market or foreign exchange market, the forex market is the most liquid and largest market in the world. On average, the daily trading volume in the forex market is more than $5 trillion. No other market comes close.

What Is Forex?

The forex market a global market on which people trade currencies from across the world. It is characteristically decentralized with currency trading conducted over-the-counter (OTC), electronically. Instead of relying on a centralized exchange, traders rely on computer networks to trade
with their counterparts across the world. The forces of demand and supply determine Forex rates or prices. As such, the Forex rate between two currencies determines how much you will get in foreign currency for your money.
Forex markets are open for trading 24 hours a day, 5 ½ days a week with trading happening in the world’s major financial centers of New York, London, Zurich, Tokyo, Hong Kong, Frankfurt, Paris, Singapore, and Sydney. Thus Forex trading takes place around the clock across different timelines. As soon as the trading day ends in New York, it starts afresh in Hong Kong and Tokyo. Since it remains active throughout the 24-hour cycle, price quotes on the Forex market keep changing.

What is Forex Trading?

Forex trading refers to the buying or selling of currencies. Every day, central banks, commercial corporations,institutional investors, corporations, and individual traders exchange currencies. Depending on the organization or individual exchanging currencies, the reasons for doing so could be to make a profit, facilitate tourism and international trade or balance the markets.
Usually, forex trading involves currency pairs in the spot or futures markets. Conventionally, a currency pair changes in value depending on the forces of demand and supply. However, political, environmental, and economic factors such as national elections, natural disasters, and wars also determine the value of a currency pair. Since currency pairs are very responsive to changes in the economy and environment, forex markets are said to be very volatile.

Currency Pairs and How They Work

All transactions on the forex market involve the buying and selling of two currencies, all at the same time. The two currencies for buying and selling are called ‘currency pairs’. One of the most common currency pairs on the worldwide forex market is the Euro/US Dollar. The currency that comes first is the base currency while that which comes second is the quote currency.

Prices

The prices of each currency pair are either either bid price or ask price. For example, in the EUR/USD currency pair, the bid price could be 1.0816, which means you can sell EUR1 for $1.0816. If the asking price is 1.0818, it means that you can buy EUR1 for $1.0818. This creates a spread of 0.0002 (1.0818 – 1.0816) or 2 pips. In the forex markets, the spread is the asking price minus the bid price. This is the cost of trading or the amount of money to be made by the forex brokers.

Position

On the forex market, trade-in progress is a ‘position’. Trading positions can be of two kinds, namely a ‘short position’ or ‘long position’. When a trader takes a short position, he or she sells a currency with the expectation that its value will decrease. The intention is to buy back the currency at a much lower value. Once the trader buys back the
currency – preferably for less than he or she sold it – the position is ‘closed’.
A ‘long position’ is the situation where a trader buys a currency with the expectation that the value will rise. Later, he or she will sell it back to the market for much more than he or she had spent.
That means the trading position is effectively ‘closed’.

Long Position

Say the EUR/USD currency pair is trading at 1.0816/1.0818. An investor can open a long position on the Euro by buying EUR1 for $1.818. In the intervening period, the trader holds the Euro hoping that it’s going to appreciate and later sell it to the market. With higher prices, the expectation can only be that the trader will get some profit. If the trader chooses to go short on the Euro, he or she will sell EUR1 for $1.816. If the Euro depreciates, he or she can sell it back to the market at a much lower rate.
Forex trading currency pairs
Forex trading involves the use of currency pairs
The forex market, has different types of currency pairs. While the major currency pairs are 7, traders can take advantage of other options. The following are the types of currency pairs on the forex market:

1. Major Pairs

Over 80 percent of currency trading involves the major pairs. Because of that, the currency pairs have high liquidity and low volatility. Major currency pairs are from the stable,less-troubled economies. They are less likely to be manipulated and come with smaller spreads compared to other pairs. Examples include the EUR/USD, USD/JPY,GBP/USD, USD/CHF, AUD/USD, USD/CAD, and NZD/USD. As is clear, all the major currencies involve the US dollar.

2. Crosses or Minor Pairs

Currency pairs in that do not include the USD are either crosses or minor pairs. Traditionally, traders had to convert crosses into USD before determiningits value in the desired currency. However, the evolution of forex trading, has made it possible to trade crosses directly. Examples include GBP/JPY, EUR/JPY, EUR/GBP, NZD/JPY, CAD/CHF, and AUD/JPY. Apart from being less liquid, these currency pairs are more volatile than the major currency pairs.

3. Exotic Pairs

Exotic currency pairs are those from the smaller, emerging economies when paired with one of the majors. In comparison to the majors and crosses, exotic pairs are fraught to higher risk, given that they are more volatile, less liquid, and more likely to be manipulated. Apart from being ultra-sensitive to sudden shifts in the economic and political spheres, these currency pairs have wider spreads. Examples include USD/MXN, GBP/NOK, GBP/DKK,CHF/NOK, EUR/TRY, and USD/TRY.

Types of Foreign Exchange Markets

To reiterate, the purpose of the forex market is to enable individuals and organizations to buy currency in a foreign country and do business there. The forex market is not just one but can be of different types depending on the transactions. Below is a look at the three major types of forex markets:

1. Spot Market

On the spot market, traders buy and sell currencies using the prevailing price. This is the price that’s established by the interaction between the forces of demand and supply. Some of the factors influencing this price include economic performance, prevailing interest rates, sentiments on the current political situation, and the expected performance of the currency in the future.
In this market, a finalized deal is referred to as a ‘spot deal’. It involves two traders with one delivering a pre-agreed currency amount to the other party and receiving a specific amount in another currency at an agreed exchange rate. Upon the close of a position, traders do the  settlement in spot cash.
Contrary to its name, transactions in the spot market take up to two days to settle. This exposes traders to losses occasioned by fluctuations in the highly-volatile currency market. In the end, traders may
suffer when prices are either lowered or raised after entering the agreement and before closing the trade.

2. Futures Market

Transactions in the futures market involve future delivery and payment at an agreed future exchange rate. Unlike in the spot market, traders in the futures market do not deal with actual currencies. What they deal in are contracts representing claims to a certain type of currency, a specified price per unit, and a settlement date in the future. Due to their standardized nature, the contracts have elements that are fixed and non-negotiable.
Essentially the transactions in the futures market aren’t prone to the volatile nature of the currency market. This type of forex trading is popular with traders who have no problem making large currency transactions with the aim of making assured returns on investment.

3. Forward Market

While transactions in the forward market are similar to those in the futures market, they are different in the sense that the trading parties can negotiate the terms of the contract. As such, the two are able to
tailor the terms to their specific needs. The transactions in this market may involve the swapping of two currencies for some time after which the currency is returned when the contract ends.
Like the Futures market, the forward market protects
investors against the many risks in the forex market. To avoid making losses due to fluctuations in exchange rates, large multi-nationals often hedge using these futures and forward markets. Due to the entry of speculators in these markets, they now account for over 70 percent of the trading volume in the forex market.

How Hedging Works in Forex Trading

By the nature of their operations, multi-national
corporations do business in different foreign countries. Thus, they are at the risk of losses due to fluctuations in the value of currencies when they sell or buy goods or services outside of their home markets. Luckily, forex trading allows them to hedge their currency risk by establishing a rate at which they complete transactions. As such, a trader may opt to buy or sell a currency in the futures or forward markets that lock in exchange rates and enable him or
her to hedge. Hedging may involve one of two main strategies, which we discuss below:

1. Strategy One

A trader may hedge by holding short and long positions at the same time to protect a current position from unexpected moves in a currency pair. In forex trading, this is a ‘perfect hedge’, given that it eliminates all the possible risks and guarantees a profit for as long as the hedge remains active.
Bizarre as it may sound, considering the opposing short and long positions, this is a strategy that’s commonly adopted by traders on the forex market. This kind of hedge often arises when a trader already has a short or long position for the long-term but opts to open a contrary trade in the short-term to benefit from a momentary market imbalance.

2. Strategy Two

It is possible for a trader to hedge with the aim of
protecting a current position from a negative move in a currency pair. Here,forex options are used to protect a short or long position in what’s known as
an ‘imperfect hedge’, since only part of the risk is eliminated by the hedge. Also, a trader has a guaranteed of part of the possible profit from that
particular trade.

Imperfect Hedge

A trader may create an imperfect hedge from the short or long positions. If in a short position on a currency pair, a trader could reduce his upside risk by buying call options or reduce his downside risk by
buying put options contracts.
Traders make imperfect upside risk hedges using call options contracts. Here, a trader has the right to buy a given currency pair at a stated price on or prior to a specified date from the seller of options in exchange for an upfront premium. Take a forex trader who is short on the EUR/USD at 1.0945 with the expectation that the pair will move lower. However,
there is a concern that the outcome of a presidential election could make it move lower. To hedge using a call options contract, he could place a bid with a price slightly higher than the prevailing exchange rate, say 1.0985 with an expiration soon after the elections.

Short Position

If the GBP/USD pair moves up soon after the election, the trader knows he has limited his risk to 40 pips (1.0985 – 1.0945) together with the premium paid for the options contract. At a price of more than 1.0985, the trader can only lose at least 50 pips and the premium since he can cover his short position by buying the GBP/USD pair from the seller of the call option at a 1.0985 strike price. It doesn’t matter what the prevailing market price is.
On the other hand, imperfect downside risk hedges are done using put options hedges. With these, the trader has the right to sell a given currency pair at a stated price, before or on a pre-determined date, to the buyer of the option for a premium.

Bearish Economy

Say you are long on the EUR/USD at 1.3255 in anticipation that the pair will eventually move higher. However, you are worried that the pair could move lower in case of an announcement of a bearish economic situation. You have the option to buy a put option contract to hedge a portion of your risk. The strike price should be below the prevailing exchange rate,say 1.3205. As for the expiration date, it should be soon after the
If the EUR/USD doesn’t move lower after the announcement of the economic situation, you will be in a position to hold onto your long trade on the EUR/USD. As it rises high, you will keep making profits, the only cost being the premium you had placed on it.
However if the economic announcement causes the EUR/USD to start moving lower, then you don’t have to worry about that since you know you have limited your risk to at most 50 pips (1.3255 – 1.3205) plus the premium you placed. That’s because you can sell your long position to the seller of the put option for a 1.3255 strike price no matter the prevailing market price of the pair.

Forex Trading As Speculation

Forex trading is entirely depended on environmental factors such as geopolitical risk, economic strength, tourism, trade flows, and interest. These factors have an effect on the demand and supply of currencies
and determine how volatile forex markets are on a daily basis. While this creates a risk, it also brings about an opportunity to benefit from changes
leading to the appreciation or devaluation of a currency. Thus, a trader could put his money on the fact that a currency could increase or decrease in value.

Extreme Profits

In that regard, forex trading is a largely speculative exercise. That’s especially as concerns day trading which  can yield extreme profits while exposing you to very high risks. Every time a trader places a trade, he or she is speculating that it will result in profits within the time interval of placing the trade and getting out of it. Together with traders in the stock market, position traders, as well as hedge funds, are all speculators.

Currency Devaluation

Many people view speculation in the forex market as controversial owing to the high likelihood of negative actions such as currency devaluation. Yet, according to economists, the forex market needs speculators. That’s because hedgers can find a group of individuals willing to take on the risk. To the naysayers, currency speculation relies on the basis of external factors such as the political situation and not free-market economics.

Interest Rates

Even though speculative in nature, forex trading is still a respectable way to make money for traders willing to risk. Say, you expect a rise in interest rates in the US, compared to Australia when the value of the AUD/USD pair is 0.80. As a result of increased interest rates in the US,the demand for the USD may increase. This will cause a fall in the AUD/USD exchange rate since traders will require fewer USD to buy the AUD.
Forex trading
To start forex trading, you have to invest cash
If the prediction of a rise in interest rates in the US turns out to be true, the price for the AUD/USD pair could decrease to 0.60. A change in value will lead to a profit is you hand gone long on the USD and
short on the AUD. Since that’s purely speculation, it could go the other way if the interest rates in the US don’t increase.

Currency as an Asset

Forex trading gets interesting when you look at currency as an asset. Currencies are called assets, given the possibility of earning the difference in interest rates between currencies in a pair. By going long on currency in a country with high-interest rates and short on one with low-interest rates, a trader can make a considerable amount in profits. Players in the market call this ‘carry trade’. Also, it is possible to earn profit from any exchange rate changes.
Traditionally, hedge funds, high-net-worth individuals, and multi-national corporations, dominated the forex market. That’s owing to the high capital requirement back then. Today, individuals can invest in forex markets through brokers or banks. Only that a majority of the online traders offer higher than average leverages, especially with individual traders who are only able to maintain a small balance in their accounts.

Is Forex Trading Worth Trying?

Despite the risk it involve, forex trading is worth trying. After all the major determinant of prices in the market are the forces of demand and supply. Thus, it is not possible for individual traders to manipulate currency prices. This is especially true for traders with access to the interbank dealings.
For those who rely on the forex dealers or brokers, the risk is in their either unregulated or semi-regulated nature. Even when with proper regulation,forex dealers may lack the safeguards, exposing traders to possible losses. Before you start it out in the forex market, check is the registration and regulation status of the broker whether in the UK or the US. Always work with a broker with the right account safeguards, just in case of insolvency declaration.
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