What is Forex Trading?
If you have ever wondered what is forex trading, then this article is for you. With all of the hype surrounding Forex Trading we thought it would be a good idea to provide some basic knowledge about what Forex Trading is, and also what it is not.
With all the false advertisements on the internet and in social media it’s easy to get the wrong idea about Forex Trading. As a result, the Forex Industry has become synonymous with things like gambling.
However, the truth is that Forex Trading has nothing to do with gambling.
It is true that there are a lot of ill-informed and inexperienced people who trade forex like gamblers.
This is just one example of some of the misconceptions people have about what Forex Trading is.
In this article, we will try to explain the core basics of what Forex trading is in very simple terms.
What is Forex?
In order to understand what Forex Trading is, let us start by reviewing what Forex is first…
The word Forex is an abbreviation for the phrase foreign exchange.
Every country in the world has different currencies. Australia uses the Aussie Dollar (AUD), South Africa uses the Rand (ZAR), and United States has the US Dollar (USD) etc.
People interact in the Forex Market every single day without even realising it…
If we wanted to buy something from another country, we would need to exchange our own currency for the currency of the country we wanted to buy from.
Let us suppose for a moment that the exchange rate of the USD versus the ZAR is 10.00…That means, it will cost me 10 ZAR for every 1 USD that I need.
Furthermore, let us also suppose that we wanted to buy a book from the USA for a value of $100, but we live in South Africa. That means, we would need to exchange R1, 000.00 (ZAR) in order to get the $100 (USD) we need to buy the book.
When I want to buy anything from another country, I need to exchange my ZAR for the currency of the other country. Thus, in simplified terms, Forex refers to the exchange of currencies.
What is the Forex market?
Now that we know what Forex is, we can take a look at the Forex Market.
The Forex market is a decentralized market where currencies are exchanged with each other.
Currencies are traded every second of every day by a global network. This network consists of Banks, Hedge Funds, Prop Firms, Companies and Traders.
The Forex Market is estimated to have an approximate daily trading volume of $5 Trillion USD.As retail traders, we trade in the spot forex market which is estimated at $2 Trillion per day.
Let’s just put that number into perspective for a second. The New York Stock Exchange has an approximate daily trading volume of $74 Billion USD.
So why should we worry about the daily trading volume? The answer to that question is LIQUIDITY.
The higher the liquidity, the cheaper it is to trade and the easier it is to get in and out of trades.
What is Forex Trading?
Now that we know what Forex and the Forex Market is, we can take a closer look at Forex Trading.
In short, Forex Trading is the speculative buying and selling of currencies.
However, we never actually physically own any of the currencies that we trade with. Yes, you read correctly, you never physically own any of the currencies you trade with in the FX market.
The trades placed in the Forex market are speculative wagers on whether the exchange rate between certain currencies will go up or down.
This is why we never trade only one currency at a time in Forex. We trade currencies against each other.
Currencies are paired together to form what we call Currency Pairs.
As we mentioned above, it is important to know that in FX Trading we always trade currencies in pairs. Your Forex Broker will offer you a selection of currency pairs to trade.
Below is an example of the most popular Currency Pair known as the EUR/USD.
Buying and Selling
One of the great things about Forex Trading is that we can profit when the market moves up or down.
Traders can execute both BUY and SELL in the FX Market.
When a trader places a buy trade they are actually speculating that the exchange rate between the two currencies in the currency pair will go up.
Similarly, when a trader places a sell trade they are actually speculating that the exchange rate between the two currencies in the currency pair will go down.
As stated above, we never actually own the currencies that we are selling or buying.
Trades placed in the FX market are two way trades.
When we place a buy or sell trade we are actually buying the one and selling the other currency at the same time.
However, don’t get too confused with how all of this works in the beginning. For now let’s just stick to the basics in this article.
How Profits & Losses are made in Forex Trading
So how exactly are profits and losses made in Forex Trading? Let us take an example using the EURUSD currency pair again…
Let us assume that we have placed a buy trade on the EURUSD currency pair. That means, I am buying Euros and selling USD at the same time. This means that we think the EURO will appreciate more than the USD.
Correspondingly, when I sell the EURUSD currency pair, I am selling Euros and buying USD at the same time. This means that we think the USD will appreciate more than the EURO.
So you can see everything has to do with the exchange rate.
If one currency appreciates or depreciates more than the other this will affect the exchange rate.
So, how exactly does profits and losses work in Forex Trading? Well, it is very simple. Let us suppose a trader speculates that the value of the Euro will increase against the USD.
The trader will then place a buy trade on the EURUSD currency pair. If the exchange rate then moves up the trader will make a profit.
However, if the exchange rate moves down the trader will make a loss.
The amount of profit and loss will be determined by the trade size or lot size the trader used to place their trade.
It is a bit more complicated and technical than that, but the aim of this article is to give readers a broad idea.
Changes in the Exchange Rates
So let us look at the idea of exchange rates in a bit more detail. The idea is quite simple once you understand the basics.
Our main goal as traders is to analyse the markets to find currencies that are gaining strength and trading them against currencies that are losing strength.
The change in value will ultimately affect the exchange rate between the two currencies. This provides great opportunities to trade.
It really is that simple. However, applying it is never easy as there are always multiple variables that affect the values of individual currencies.
Let us look at a practical example of how this works…
Now, please note that this was a very simplified example. In reality the intricacies of how the markets move and how to trade them are a lot more complicated than that. However, this example should get you off to a good start.
What Forex Trading is not
Our article would not be complete without also discussing what Forex Trading is Not. A lot of beginner traders has the wrong idea of what Forex Trading is. Let us look at a few examples below…
Forex Trading is not gambling
The most important thing for beginner traders to realise is that Forex Trading IS NOT GAMBLING! Furthermore, Forex Trading IS NOT A GET RICH QUICK SCHEME!
Unfortunately, false advertising has given Forex trading a very bad reputation. There are so many scammers and fraudsters in the FX industry that try and con people out of their money.
As a result, people normally associate Forex Trading with gambling or get rich quick schemes. This is very far from the truth.
We have already seen above that Forex Trading is the speculative buying and selling of currencies. Just like any other speculative investment there is always associated risks.
People need to be aware that it is possible to lose all of their capital in a single Forex trade. This is especially true if you do not follow proper risk and money management.
Unlike gambling, professional Forex Traders take calculated risks. Experienced FX traders find high probability trading opportunities based on extensive market analysis.
That is another way of saying that they don’t rely on luck! Professional traders does not place any random trade and simply hope for the dice to roll in their favour.
Successful Forex Traders take trades in line with probabilities and work hard to minimize their risk wherever they can.
Real traders also know that Forex Trading will not make you rich quick! There is no such thing! It will take hard work for traders to become consistently profitable. This brings us to our next point.
Forex Trading is not easy
This is a big one! Forex Trading IS NOT EASY! Oops! That wasn’t what you wanted to hear right?
Well that is the truth. Do not believe scammers that try to sell Forex Trading as something easy.
Forex Trading has never been easy and it will never be easy.
Just like any other career, it will take lots of time and commitment to trade successfully. Do not underestimate the complexities of trading the financial markets.
If it was easy, everybody would be doing it.
Forex Trading is a sow and reap endeavour.
If you are not willing to sow the necessary time and commitment you will not reap the rewards.
All the knowledge in the world will not help you if you do not know how to apply it. The experience required to apply is only gained through lots and lots of practise.
We trust the elementary information we provided in this article was sufficient to give you a basic idea of what Forex Trading is. It can be a very lucrative and exciting investment for those who are able to master it.
However, being successful in Forex Trading will require very hard work and commitment. Feel free to visit our website and our blog section for more helpful articles about Forex Trading.
As always, our advice is to make sure you invest in good Forex Training before trading with real money.
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