“foreign exchange,” or “Forex Markets,” describes exchanging one currency for another. Everyone from individuals to multinational corporations to whole nations trades in this market, making it the busiest of its kind. 1 Participating in the global foreign exchange market is as simple as exchanging your dollars for euros while on vacation.
The demand for a currency will drive its value up or down in relation to other currencies at any moment. So that you may take the next step and begin forex trading, below are some fundamentals regarding the currency market.
Highlights and Lessons
- Trade in currency pairings takes place on the foreign exchange market.
- Traders take positions in currency markets based on their expectations of future price movements in pairings of currencies, such as the Euro to US Dollar (EUR/USD).
- Pip values are used by currency traders to track small price fluctuations.
Getting Started with Currency Pairs
It would help to familiarize yourself with currency pairings and what they represent before making your first trade.
Trading in the foreign exchange market always occurs between two currency pairings. Since two different currencies are involved when exchanging USD for EUR, the exchange rate will always reflect the value of USD in relation to EUR. If you want to know how much USD it will cost you to purchase one EUR, you can look up the EUR/USD exchange rate (EUR).
In the foreign exchange market, currency pairings are represented by symbols. Since EUR represents, the euro and USD represents the U.S. dollar, the EUR/USD pair is written as EUR/USD. The Australian dollar (AUD), British pound (GBP), Swiss franc (CHF), Canadian dollar (CAD), New Zealand dollar (NZD), and Japanese yen (JPY) are all frequently traded currency symbols (Japanese yen). 2
A market price is assigned to each currency pair. The price is the amount of the second currency that is needed to purchase one unit of the first currency. For example, one euro now buys 1.3635 dollars according to the current exchange rate for the Euro/Dollar currency combination.
Flip the pair to USD/EUR and divide 1 by 1.3635 to get the Euro price of one U.S. dollar (or whatever the current rate is). This specific calculation yields a value of 0.7334. At the current exchange rate of 0.7334 euros per USD, one USD can be purchased for 0.7334 euros. Since currency exchanges occur all around the world at all hours of the day and night, the pair’s value is volatile throughout the week.
An Overview of the Market’s Pricing
Gaining an understanding of the tiny amount of new vocabulary used to explain the value of currency pairs is a necessary first step in learning forex trading. Learn how to do the math, and you’ll be well on your way to making your first foreign exchange transaction.
Common daily fluctuations for several pairings of currencies range from 50 pips to 100 pips (sometimes more or less depending on overall market conditions). When referring to currency pairs, the fourth decimal place, or the second decimal place when JPY is involved, is referred to as a pip (an abbreviation for “point in percentage”). A 50 pip rise in the EUR/USD exchange rate results in a profit of $50 if you buy at 1.3600 and sell at 1.3650.
Your hypothetical profit from the above exchange would be proportional to the amount of currency you bought. A micro lot consists of one thousand dollars worth of currency; thus, if you made a purchase of this size, your profit would be $5 (50 pips multiplied by $0.10). The profit would be $50 if you purchased a “small lot,” which is 10,000 units because each pip is worth $1. Each point is worth $10, so if you purchased a 100,000-unit (“normal lot”), your profit would be $500.
The “pip value” indicates the monetary worth of one pip. The pip as mentioned above values apply to all pairs where the US dollar is the secondary currency. Depending on which currency is shown initially, the pip value might change. For instance, the value of a pip in the USD/CHF pair may be calculated by dividing the standard pip value (discussed above) by the current exchange rate. If the current exchange rate is 0.9435, then one micro lot is worth $0.10/0.9435 = $0.1060. The method is repeated but with a factor of 100 added in for JPY pairings (USD/JPY).
When analyzing a forex price chart, the first currency displayed in the pair is always considered the directional currency for trading purposes. If the EUR/USD exchange rate is increasing in value, then the euro is gaining ground against the US dollar. A dropping price on the chart indicates that the euro is becoming less valuable when compared to the dollar.
Note
Using a “paper trading account” to see how prices change in real time while making fictitious deals is a great method to get a feel for foreign exchange (so there is no actual financial risk to you). Multiple brokers now provide no-risk “paper trading” accounts that mimic real trading accounts down to the last detail but don’t put your money in danger. In addition, day trading and FX trading may be practiced on several available online simulators.
If you can get your head around the above ideas, you’ll better understand what’s going on when you see a currency pair on a chart increasing or decreasing. For example, the profit potential of a specific price change may be better understood by calculating the difference in pips between two price points.
Questions Often Asked
When does the market for foreign currency start and when does it end?
Due to the global nature of currency exchanges, trading in the FX market always continues. The foreign exchange market is open from Sunday evening (5:00 pm EST) to Friday evening (5:00 pm EST).
Forex: What does “spread” mean?
The “spread” is the price differential between the purchasing and selling prices. Brokers may earn from the deals they facilitate by keeping a portion of the spread. The gap between buying and selling is less when trading a currency pair that is very liquid and steady. Increased spreads are to be expected between low-liquidity, high-volatility currency pairings.
The term “spread trading” may also be used to describe a kind of trading in which identical long and short bets are placed at the same time. This enables you to hedge your bets by taking a neutral or slightly positive stance, reducing risk while preserving some possible reward.
What does the term “scalping” refer to in the world of foreign exchange?
In the context of trading, “scalping” refers to the smallest time frame. It’s a method that works in every market, whether FX, stocks, or futures. Scalpers often get out of a transaction as soon as possible when it turns a profit. This usually doesn’t take more than a few seconds.
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