What is Forex? A Comprehensive Guide for Beginners

The investment world has numerous opportunities to trade in various markets but one of the most popular markets among many others is the Foreign Exchange Market or Forex market. It is the world’s most traded financial market as it comprises trading of millions of dollars each day worldwide. Further, we will explore the various aspects of Forex.

The Basics of Forex

The global marketplace where currencies are bought and sold is called the Forex Market. It is the largest, most liquid financial market in the world where one currency is exchanged with another. The daily volume of trade in the FX market exceeds $6 trillion. The goal there is to profit from fluctuations in exchange rates, hedge against currency risk, or facilitate international trade. The Foreign Exchange Market involves trading in currency pairs such as EUR/USD, USD/JPY, etc.

There are several types of markets where foreign exchange is transacted every day. Listed below are the three diverse kinds of forex markets:

1. Spot Market: The spot market involves the immediate exchange of currency between buyers and sellers at the current exchange rate. Spot Market makes up for most of the currency trading. Commercial, investment, and central banks constitute a major number of spot trades as they trade not only for themselves but also for their customers.
2. Forward Market: In Forward Market, two parties agree to trade currency for a specified price and quantity on a future date. There is no exchange of currency when the trade is initiated. Forward market is useful for hedging. There is an involvement of two parties which can be companies, governments, individuals, etc. Forward markets lack centralized trading which leads to counterparty risk.
3. Futures Market: Futures Market is like Forward Market in the way it functions but the only stark difference among the two is that the futures market uses centralized exchanges. Owing to centralized exchanges there is no counterparty risk for any party involved in the exchange.

Role of Forex in Financial Markets

The foreign exchange market is distinct as it does not have a single, physical address like Wall Street. Instead, it is a vast global network of computers and brokers. Unlike other financial markets, Forex operates 24 hours a day, five days a week as it has a decentralized nature, with trading centres scattered all around the world. 

Forex has many major players placing trades at all times. Some of them are as follows: 

1. Governments and Central Banks

   Central banks serve as key participants in the forex market since they represent for their country's government. Currency rates are significantly influenced by the open market activities and interest rate policy of a central bank.

   A central bank is responsible for setting the exchange rate for its national currency. Its currency will trade on the open market under this system of exchange rates. There are three distinct types of exchange rate regimes, floating, fixed, and pegged.

   Any action taken by the central bank in the FX market is to stabilize or boost the competitiveness of the currency of that nation. To increase or decrease the value of their currencies, central banks and speculators may intervene in the market. These tactics are employed by central banks to regulate inflation. For forex traders, their actions also function as a long-term indicator.

2. Commercial Banks

   Commercial banks are among the key players in the foreign exchange. They not only trade for themselves but also serve as channels for their clients to participate in the market. They support the FX market and are vital for maintaining liquidity. Commercial banks take part in the market as speculators in addition to helping their clients execute their trades. The are called proprietary trading desks. Here, the goal of the prop traders is to generate profits for the bank. 

   Banks are one of the best-informed players in the forex. This is simply because of the infrastructure, the amount of capital they have access to, and perhaps most importantly, their knowledge of the market.  

3. Retail Traders

   Individual traders may employ a prime broker if they have the requisite cash, although they often enter the market through a retail broker. Retail traders can use leverage because it just costs a minimal sum of money to create a trading account.  

   If compared to MNCs and banks, retail traders constitute a small volume of forex traders. Nevertheless, the volume of such traders is rising rapidly and gaining momentum. Retail investors base their trades on both technical and fundamental factors. 

4. Commercial Companies/MNCs

   Various corporations, such as international companies or exporters/importers, are included in this category. Their primary objective in currency trading is to hedge their currency risk or collect the foreign currency they require to pay their employees abroad and similar objectives.  

   Also, offshore investments can also gain from hedging against currency risk, which can increase their level of safety and security. 

5. Hedge Funds

   Hedge funds are the most well-known members of the category of participants of the forex market. Hedge funds can hold significant market positions as important participants of the market.

Role of Currency Pairs and Exchange Rates in Forex

In Forex, currencies are traded in pairs. A currency pair is a combination of two currencies, the base currency, and the quote currency . The exchange rate tells traders how much of the quote currency is needed to buy one unit of the base currency.

For more detail, watch these videos:

All trades include the simultaneous buying and selling of two different currencies, but the currency pair itself can be viewed as a single unit, an item that is bought or sold. A currency pair is purchased from a forex broker by purchasing the base currency and selling the quote currency. Conversely, the base currency is sold, and the quote currency is received when traders sell the currency pair. 

The bid (buy) and ask (sell) prices of a pair of currencies are used to quote them. The price at which the forex broker purchases the base currency from a trader in return for the quote or counter currency is known as the bid price. The price at which the broker sells the broker the base currency in exchange for the quote or counter currency is known as the ask price, also known as the offer.

There are three types of currency pairs in foreign exchange:

1. Major Pairs: Major currency pairs include the circulation of strong economies, with the most widely traded and liquid currencies. They mostly include USD (US Dollar) paired with other powerful currencies of the world. A few examples of major currency pairs are GBP/USD (British Pound/US Dollar), EUR/USD (Euro/US Dollar), and USD/JPY (US Dollar/Japanese Yen).
2. Minor Pairs (Cross Pairs): Minor pairs exclude the USD and make a currency pair with 2 other major currencies. Minor currency pairs include the Euro/British Pound (EUR/GBP) and the Australian Dollar/Japanese Yen (AUD/JPY) among many others. These might have slightly wider spreads and less liquidity than major pairs.
3. Exotic Pairs: These pairs include one major currency and the other currency of an emerging economy. They are a risky trade because they are not very liquid and are more volatile. USD/SGD (US Dollar/Singapore Dollar) and EUR/TRY (Euro/Turkish Lira) are examples of exotic pairs.

The most traded currency pairs are as follows:

1. EUR/USD (Euro / US Dollar)
2. GBP/USD (Pound / US Dollar)
3. USD/CHF (US Dollar / Swissy)
4. USD/JPY (US Dollar / Japanese Yen)
5. AUD/USD (Aussie / US Dollar)
6. NZD/USD (Kiwi / US Dollar)
7. USD/CAD (US Dollar / Loonie)

How Forex Trading Works?

The world of forex can come across as complex and daunting to people. That does not take away from the fact that if one has learned, read, and understood the working of the foreign exchange, they can turn themselves into successful traders.

Following is a list of steps involved in placing a trade: 

1. Choose a Currency Pair

   Trading in the forex essentially refers to converting one currency's value into another. In other words, traders will never buy one currency without simultaneously selling another. As a result, they always trade pairs of currencies. The majority of new traders begin by trading the major currency pairs, but one can trade any currency pair that they have as long as they have enough funds in their account.

2. Research and Analysis

   Research and analysis are pre-requisites based on which traders should act upon, but it is overwhelming for everyone to grasp as there is a wealth of forex resources available. If searched and researched in the correct manner, there are many resources that will stand out and will come across as useful. Traders should be on a look out for current and historical charts, economic announcements, and technical and fundamental indicators of the FX market.

3. Choose the broker

   Finding the best forex broker is critical. Not all brokers provide the same standard of services or are reliable. One must therefore take the time to research the numerous brokers who provide services for forex trading.

   An ideal forex broker should be simple to use, provide excellent customer support, have low transaction charges, and have an easy account opening process. Traders must assess the downtime frequency of the brokers. Given the volatility of forex market and the need for speedy trade executions, brokers with little to no downtime should always be preferred.

4. Practice trading with Demo Accounts

   The practice of trading in currencies in a simulated setting is known as virtual trading. There are many online trading simulators that let traders trade with practice money and demo accounts while simulating a real-time market environment. Traders may learn currency trading quickly and experiment with new trading methods and tactics by engaging in extended virtual trading practice sessions.

   One does not have to be concerned about losing money on trades because these are not actual funds they are dealing with. Traders may instead invest some time in learning the ropes and attempting to analyze the trades they wish to place. This can help them gain some much-needed perspective on how to approach real-time forex market. 

5. Going Long or Going Short – Picking the position

   Depending on whether traders anticipate the market to rise or fall, they can take long or short positions while trading. When traders expect that the price of a currency pair will rise in the future, long or purchase bets are kept open. If traders anticipate a decline in the value of the currency pair, they will take a short or sell position to limit losses. 

6. Place the trade

   The market is highly volatile which can lead to erratic swings in the price. Hence, it is great if the traders start slow and use just a fraction of the available capital at first to get the hang of trading the forex. Since, the market primarily runs on leverage, traders can take large positions with small initial deposit. This enables the traders to have access to greater profits in case of successful trades. On the downside, if the trades go against the traders, they may also incur severe losses. Therefore, it is recommended to start slow.

Trading Platforms and Brokers in Forex

A forex trading platform is a software that enables traders and investors to track accounts and place trades through brokers. Other services, such as real-time data, charting tools, news feeds, and even premium analysis, are included with trading platforms.

Trading platforms like MetaTrader 4 (MT4) and MetaTrader 5 (MT5) are two of the most popular forex trading platforms used by traders worldwide. MT4 offers a user-friendly interface, advanced charting tools, and automated trading capabilities. On the other hand, MT5 has additional features such as more advanced charting tools, a built-in economic calendar, and the ability to trade on other markets such as stocks and commodities. Brokers often offer either MT4 or MT5, or both, for their clients to use. By using these platforms, traders can easily track their accounts, place trades, and access real-time data, news feeds, and premium analysis provided by brokers.

For detail comparison between MT4 and MT5 visit: Difference Between MT4 & MT5

A broker is where buyers and sellers go to buy and sell instruments like currencies and may also conduct CFD trading. A forex broker acts as an interface between the trader and the market. In other words, traders can get into the market with the help of these brokers. Brokers act as a bridge to the market which is connected to the trading platform.

Forex brokers enable traders to place trades through them on these trading platforms at any given time, from anywhere. The services provided by these brokers can be tailored according to the needs of the traders.

Strategies, Psychology and Risk Management in Forex

Strategizing, managing risks, and understanding the psychology of traders is of utmost importance when it comes to getting a grip on the market.

Forex Trading Strategies

Forex market caters to a diverse range of participants and trading styles. Some common approaches to trading are:

1. Scalping: Scalpers place small, quick trades to profit from minor price movements.
2. Day Trading: This type of trading style has traders opening and closing positions within the same trading day.
3. Swing Trading: Swing traders hold positions for several days to weeks, aiming for larger price movements.
4. Position Trading: Traders who are position trading have a long-term perspective, holding trades for weeks to months.

Also Read: Best Forex Trading Strategies and Techniques

The Psychology of Forex Trading

The emotions and experiences the traders have while trading come under the wide spectrum of trading psychology. While some of these feelings are helpful and should be acknowledged, the others like greed, fear, and anxiety should be resisted. It is tough to master the psychology of trading owing to its complexity.

It is widely known that traders encounter the negative emotions when trading rather than the positive ones. One may feel nervous and a sense of loss if they lose a trade or they can also have numerous doubts and confusion which leads them to doubling down on losing positions as fear of facing a loss transforms into greed.

Traders who are able to take advantage of the positive traits of trading psychology while controlling its negative ones are better equipped to deal with the volatility of the financial markets.

Also Read: Trading Psychology in Forex: Rules for Traders

Risk Management in Forex

The Forex market is highly liquid which enables the traders to enter and exit positions with ease. It is accessible to individual traders worldwide, due to the presence of online brokers. Forex provides traders with the opportunity to diversify their portfolios. However, forex has its share of risks as well.

Measures taken by traders that help them guard against the potential loss of a trade is known as risk management. Taking risk does increase the chances of sizable gains but also increases the probability of greater losses. Therefore, a crucial skill for any trader to possess is the ability to minimize risk to reduce losses while maximizing gains. Currency traders can reduce losses brought on by fluctuations in exchange rates by employing risk management strategies. Successful Forex trading requires in-depth understanding of market analysis and risk management techniques in times of need.

Tips for Beginners and Resources

Trading can often seem intimidating to beginners, and it can be challenging for them to understand where to begin. Following are a few easy tips that may streamline the flow of trading in forex. 

1. Choose the broker: Choosing the correct broker as per the requirements of the traders. The broker must be chosen after much thought and deliberation keeping a few factors in mind like, access to leverage, client fund security, customer support, etc.
2. Trading Plan: Trading plan of a trader must align with their trading goals and style to gain the maximum profits.
3. Continuous Learning: Constant upskilling can help traders keep up with the ever-changing scenarios of the market.
4. Starting slow: It is advisable to start slow and small in the market as beginners lack the experience of seasoned traders who might foresee the forthcoming events which might lead to huge losses. 
5. Keeping emotions in check: It is imperative to have a clear mind and thought while trading the FX market. Not getting carried away in case of gains and losses is the key to being a successful trader. 

Getting Started with Forex Trading

Trading in forex involves buying one currency and selling the other. It involves the speculation on the direction of currency exchange rates. Traders select a currency pair they want to trade. After the currency pair is chosen, traders use various tools and analysis methods, including technical and fundamental analysis, to predict whether the base currency will strengthen or weaken against the quote currency.

Based on their thorough analysis, the traders decide to buy the currency pair, anticipating that the base currency will appreciate. Later, they enter the trade by going long on the chosen currency pair. Once the trade is active, the traders monitor the market. If the exchange rate moves in their favour, they may close the trade and earn some profit but if it moves against them, they may incur a loss. Traders use stop-loss orders to contain the probability of potential losses and take-profit orders to earn profits at predefined levels.

Beginners must practice the concepts of Forex with the help of a demo account till the time they are fully prepared to switch to live markets. Sign up with Exclusive Markets today to learn and trade!

Conclusion

As lucrative as the Forex is, it is also particularly challenging. It allows the traders the chance to profit from shifts in currency rates. It is a dynamic space given its trading cycle, global reach, and availability of trading platforms. Participants must, however, approach Forex trading with a solid grasp of the market, a well-thought-out plan, and a dedication to risk management.