What Is Forex?

If you believe that trading is easy and effortless, you may be in for a big surprise. If you are not careful, your entire investment account may be wiped out in no time. Forex trading, just like trading any other investment vehicle, is not easy. You need practice and education to enhance your chances of success. So, what is Forex, and how do you know if trading currencies is right for you?

The currency market is the world’s largest investment market, and it doesn’t stop growing. It regularly surpasses the US $4 trillion mark in daily average turnover. To help you imagine how big the Forex market is, compare it to the NY Stock Exchange that has a daily volume of “only” US $25 billion.

In the past, when the question “what is a Forex trader” was asked, the answer would simply be a professional trader or a large financial institution. This was true since a large portion of the Forex market volume then was contributed mainly by these big players. Today, however, with the advent of highly improved and efficient trading platforms, more and more retail traders have joined the fray, and have discovered that Forex trading is well suited to their investment goals.

How Forex Trading Works

The forex market is open 24 hours a day, 5 days each week. It closes on Friday evening and opens again on Monday morning. However, the 24-hour/day trading sessions may be misleading. This is because there are actually three trading sessions happening in different time zones. One is in the US (New York), one in Europe (London), and Asia (Tokyo or Sydney). While there are some overlaps in these sessions, the movement of each of the market’s main currencies happen during the market hours.
This means some particular currency pairs will experience more trading volume at specific sessions. For instance, if you are interested in trading US dollar-based pairs, you will find the largest volumes during the US trading session.

Currencies are traded in different lot sizes. A micro lot is equivalent to 1,000 units of a particular currency. If your trading account is denominated in US dollars, one micro lot represents US $1,000. Meanwhile, a mini lot represents 10,000 units of your account currency, and a standard lot is equivalent to 100,000 units.

Understanding Pairs and Pips

Forex trading is always done in currency pairs. As opposed to stock trading where you can purchase or sell one type of stock, forex markets require buying a currency and selling another.

Almost all currencies on the market are priced out up to the 4th decimal place. One pip (short for Percentage in Point) is the smallest trade increment. One pip is equal to 1/100 of 1%.

Usually, beginner and retail traders buy and sell currencies in micro lots. This is because a micro lot pip is equivalent to only a 10-cent price movement on the market. This way, it would be easier to manage losses in case the trade does not turn out as well as intended or hoped for.
Potential losses, as well as potential profits, when trading in micro lots would be smaller compared to trading in standard or mini lots. One pip in a mini lot is equivalent to $1, while a standard lot pip is equal to $10.

The fact that some currencies move by as wide as 100 pips or even more in one trading session makes trading in micro lots more attractive to smaller investors as it makes it possible to minimize the losses to a more manageable level compared to trading in bigger lot sizes.

Fewer Products to Understand and Manage

Unlike stock trading where there are thousands of available stocks for trading in global equity markets, majority of the total currency trading volume is restricted to only around 18 currency pairs. There are many other currency pairs that are traded outside of the 18, although in much smaller volumes.
Of the 18 currency pairs that contribute the bulk of the world’s total Forex trading volume, 8 currencies are more popularly traded than the rest. These are the:

  • US dollars (USD)
  • Swiss Francs (CHF)
  • British pounds (GBP)
  • Euro (EUR)
  • Canadian dollars (CAD)
  • Japanese yen (JPY)
  • Australian dollars (AUD)
  • New Zealand dollars (NZD)

As previously mentioned, forex trading is not a walk in the park – even though there are fewer trading options compared to the stock market. Fewer products to learn and understand only makes portfolio management and trading itself much easier to handle.

What Triggers Currency Movements?

Today, there is an increasing number of stock traders who are starting to dabble in forex markets because the similarities in the two investment vehicles. For one a lot of market forces that trigger stock market movements are also existing in the currency markets. One of the biggest of these forces is supply and demand. This simply means that when there is more demand for US dollars, the value of the US dollar rises, and when there is more than enough US dollars in circulation, its price drops.

The fact that there are fewer trading options in forex trading makes the shift from stocks to forex a lot simpler. Likewise, other stock market movement-triggering forces like geopolitical tensions, new economic data coming from influential countries, and new interest rates can also affect currency market movements.

Final Word

Similar to other types of investments, learning how to trade Forex is not rocket science. However, finding the right trading strategies that will work for you requires a lot of practice and effort to master.

The good news is, most reputable Forex brokers offer free dummy or virtual trading accounts that will allow you to practice trading in actual trading environments using virtual money. This way, you will not lose your hard-earned money as you find the right trading strategies that will work for you.