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What is Forex Trading?

Trading CFDs and Forex may expose you to significant losses

About the Online Forex Trading Market

We can easily define forex trading as trading between different foreign currencies. The popularity of this asset class has recently increased due to the relative ease to obtain information about macroeconomic and political developments which are affecting forex rates.

That said, forex trading is also happening in the real world all the time. For example, if you are traveling abroad to a country that is not using your currency you are typically preparing for the trip by exchanging money. Transactions such as this happen on a large global scale and are affecting forex markets on a daily basis.

Today, the forex market is considered to be the most liquid market in the world, primarily due to the high frequency with which currencies are being exchanged worldwide. The Bank for International Settlements' (BIS), December 2016 statistics report shows that the total liquidity traded in currency markets daily is roughly $5.1TR.

Thanks to the high liquidity of the forex market, it is relatively stable to the rest of the spectrum. Seeing moves in excess of 2% per day is a rarity in normal market conditions. This is appealing to new traders, since they can manage their risk easier. That said, traders love volatility to a certain extent and day traders, investors, and scalpers, get to enjoy a fair bit of it throughout the year.

One other key aspect of the foreign exchange market is that it is decentralized. There is no particular location where forex is traded, however, it is important to note the different trading sessions. The trading week starts on Sunday evening around 22:00 GMT when Sydney opens. Typically the most active trading session is in London which opens at 08:00 GMT and closes at 17:00 GMT. New York is also adding to the flow between 01:00 GMT and 22:00 GMT. Throughout the week, the forex market doesn't close, which is another aspect that traders like.


What is the Spread in Forex?

The spread is the difference between the buying and the selling price of a currency. This is the cost of trading currencies, and the profit of your Forex broker each time you trade.


What is a Pip in Forex?

The pip is the smallest price increment which the price can make. Forex is traditionally quoted in four digits after the decimal as in EUR/USD 1.1285. Some brokers are also quoting pippettes or fractional pips, adding a fifth digit after the decimal: EUR/USD 1.12854. Depending on the pair you are looking at you will see 5 to 6 numbers, with Japanese yen quotes being displayed with 2 or 3 digits after the decimal point - USD/JPY 112.56(5).

Below is an example of the definition of a pip in forex for the most famous currency pair: the EUR/USD.

what-is-forex-trading

The pip in this example is the fourth digit after the decimal, which is the number 2.

Here’s another example of the USD/JPY pair.

what-is-forex-trading

The pip in this example is the second digit after the decimal, which is the number 0.


The next logical question is how to calculate pips in Forex?

In fact, several renowned trading platforms offer their traders the possibility to automatically calculate the value of the pips when trading forex.

However, here is an example to fully-understand how the pip value is calculated.

The base currency’s pip value = (0.0001 / exchange rate) * Contract size

The best example in this context is USD/CAD = 1.2740, where the Pip value = 100,000 USD * (0.00001 / 1.2740) = $7.84.


What is a Lot?

The volume of each forex trade is sized in lots. Traders can accommodate the appropriate volume of their trades in accordance to their risk-tolerance and the size of their account.

There are three lot sizes:

Standard lot - equals 100,000 units of base currency, each pip equals $10 in the EURUSD.

Mini lot - equals 10,000 units of base currency, each pip equals $1 in the EURUSD.

Micro lot - equals 1000 units of base coin, each pip equals $0.1 in the EURUSD.

Your position's lot size equals the volume traded on the forex market

Size your position appropriately in order to avoid taking excessive risks

The value of every pip in forex is determined by the trade's size e.g. the lot size.


What is Forex Leverage & and what Does Trading on Margin Means?

This section will explain the concept of trading Forex with leverage, its mechanics, and how to do it.

Leverage in forex is a tool provided by brokers; its main objective is to amplify the size of the trader’s capital, so it makes economic sense to trade small price changes.

As an example, trading a 0.1% price change with a small trading account makes little sense to most traders, but with the use of leverage, the trader can amplify this 0.1% price change. So instead of making a 0.1% impact on the trading account, it could be 1%, or 10%, etc. We just need to remember that leverage amplifies our gains as well as losses.

Trading accounts tend to default to one of the following leverage multiples: 50:1, 100:1, 200:1, 300:1, 400:1, and 500:1. However, the effective leverage is ultimately controlled by the individual trader.


How to Calculate Leverage in Forex?

If the available leverage is 300:1, then this means that every dollar on the trader’s account can purchase $300. The trader only needs to set aside a portion of his capital, in this case, one dollar, and the broker lends the remaining $299 to its client. Once the deal is closed, the client returns the $299 to the broker. All of this is automatically managed by the trading platform.


Trading Forex on Margin

Margin and leverage are different sides of the same concept. Let's say that the trader’s account balance is $1000 and that he chooses leverage of 1:100 to buy a standard USD/CAD contract (100,000 units)

The trader would need to set aside the $1000 as margin with his broker, to open the $100,000 position. So effectively, the margin requirement as a percentage of the total position results in certain leverage. The higher the margin requirement is in percent, the lower is the leverage, as shown in the table below.

The table below shows the required margin in Dollars need to open a standard and mini contract at different margin levels.

LeverageMargin requirementStandard Contract has 100K units of base currencyMini contract has 10K units of base currency
100:11%1000 Units (e.g. dollars)100 Units (e.g. dollars)
200:10.5%500 Units (e.g. dollars)50 Units (e.g. dollars)
400:10.025%250 Units (e.g. dollars)25 Units (e.g. dollars)

What Are the Advantages of Trading Forex?

High Liquidity

According to the Bank of International Settlements (BIS), the daily Forex volume exceeded $5.1TR, which protects the trader in currency markets as no person or financial entity can manipulate or control price fluctuations in long periods of time

In fact, online currency trading differs from Stock markets by being extremely volatile in the short-term, and range bound in the multi-year perceptive.

A 24/5 Market

Forex traders can work around the clock, five days a week, as the FX markets only close for the weekend.

The 24-hour trading gives traders the freedom to trade anytime, whether they have a full-time job or not. Stock markets are not quite as flexible, they close and open every day, and price fluctuations tend to be limited to certain hours each day.

Profits on Price Rises and Declines

A Forex trader can profit on currencies, whether their price is increasing or decreasing. If the price movement is bullish, traders tend to buy; on the contrary, if prices fall, traders can make a profit on the decline (also known as short selling).

Easy Monitoring & Analysis

Online FX trading is limited to a few selected currencies such as the USD, Euro, British Pound, Australian, and New Zealand dollar, and the Japanese Yen, which can be easily covered by a private investor, unlike the stock markets where there are many shares and companies to track.

Ability to Trade Small Amount of Money

Currency trading is known for its low spreads (low costs to trading), and access to leverage, this gives traders with small deposits the possibility to profit on the global markets.

Decentralized Activity

Traders can exchange Forex online; through modern trading platforms provided by brokerage firms, regardless of their location.

Trading Without Commissions

Brokerage firms make a profit from spreads; they do not charge additional fees for their services or trading platforms.

High Leverage

Forex leverage is a tool provided by the financial intermediary to the client. It aims to maximize the traders’ capital and helps them execute transactions that exceed their capital.

Opening a Demo Trading Account

Forex Trading firms offer risk-free, demo trading accounts where traders can test their strategies and get the feel of the Forex market’s dynamics. There is no difference between the real Forex trading account and the demo Forex trading account. However, the latter requires funding, whereas the demo Forex trading account has fictitious capital.


Risks of Trading Forex

Albeit Forex trading exhibits several advantages, it also bares many risks; the speculation activity could lead a trader to overuse leverage, which can be costly sometimes. Any occurring loss in this case results from mild market movements; therefore, traders should focus on carefully managing their capital – according to their risk-tolerance strategy. Moreover, traders should always open a stop loss position for all their deals to avoid dramatic account losses, or trading through the margin.

On another note, given the volatile character of the financial markets and the major fluctuations it undergoes due to political or economic events, price gapes leading to negative account access could arise. That being said, it is recommended to avoid trading during major political events, or presidential elections, or even during the holidays.


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