Forex Trading

November 23, 2010Forex Tradingby EconomyWatch

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Forex trading, also known as FX trading, involves the buying and selling of currencies of various nations. In the forex trade, currencies are exchanged continuously in the forex market that spans the globe. People are presented with profit-making opportunities in forex trading when the value of one currency fluctuates against that of another.

People conduct Forex Trade to:

    1. Make direct foreign investments

    2. Earn profits from short-term fluctuations in the value of a currency pair

    3. Manage their existing positions in the market

    4. Fulfill their import and export requirements

As the forex market does not have any centralized exchange, trading is conducted either through the Electronic Broking System (EBS) or on the Internet. Online forex trading is most popular among individual investors. High leverage, liquidity and flexibility are the three factors that attract people to forex trading.

How is Forex Trading Conducted?

As with other transactions, forex trading involves buyers, sellers and intermediaries.While buyers and sellers in this market could be banks, hedge funds, investment management firms, commercial companies and retail investors, the intermediaries are brokers. Forex brokers act as market makers and place bid and ask prices for a currency pair on behalf of a buyer or a seller. Buyers make money by purchasing a currency at a lower price and selling it later at a higher price. All transactions by individual traders in the forex market occur through brokers. 

Benefits of Forex Trading

The benefits of forex trading are:

    1. It is conducted in an extremely liquid market. Thus, you are unlikely to get stuck in a trade. You can open and close any position at your desired level.

    2. Traders can benefit in both rising and falling markets. You can take a short position (selling the currency pair and buying it back at a lower price) or long position (buying the currency pair and selling it later at a higher price).

    3. Provides traders the option of trading in small lots. If you are a novice trader, you can opt to open small accounts and start trading with small lots. This allows you to begin with little capital and limit your risks.

    4. Traders do not have to pay commissions to brokers. The cost of the transactions is built into the currency price and is known as the spread, which is the difference between the buying and selling price at any given time.

Drawbacks of Forex Trading

Forex trading can lead to huge losses if the trader is a novice. The lack of prompt action can also lead to substantial losses.The forex market has become the cynosure of world traders. The ease of trading and the leverage offered make forex trading truly viable and lucrative. However, one should learn the various aspects of the forex market before investing. Incomplete knowledge about forex trading can cause huge losses.   

Margin Forex Trading   

Forex trading amounts to the largest amount of financial transactions in the world. The forex market has become the cynosure of world traders. The ease of trading and the leverage offered make forex trading truly viable and lucrative. However, one should learn the various aspects of the forex market before investing. Incomplete knowledge about forex trading can cause huge losses.   

Margin Forex Trading   

Forex is generally traded on margins. This means that a trader can open an account at a small price and trade through it. Due to the high leverage offered, it is possible for even low deposits to yield huge profits. Most of the brokers offer margin accounts and let traders operate at as low as 1%. This means that for a trade worth $100,000, the trader only needs to deposit $1,000. Leverage works both ways, which means that it multiplies both profits and losses. 

Forex Trading Quotes  

Forex trading is done through quotes that indicate the rate of exchange of one currency in terms of another. For example, in the quote of USD/JPY- 94.9036/94.9040, the figures mean that by selling USD (base currency) a person will get 94.9036 JPY whereas buying a USD will cost 94.9036 JPY. The buying price is usually high and the difference between the two prices is measured in pips. In the aforementioned example, there was a 4 pip difference.  

Forex Trading: Spread and Commissions  

Most of the forex brokers operate without any commission. They make money through the spread differences. Spread is the quote specific to a currency pair. Even a single pip movement can amplify into big profits through leverage. 

Forex Trading: Spot or Forward 

Forex trading is done in two ways:

  • Spot

  • Forward

Spot trading is done in real time on current prices. The traders ask or bid for the currency through the trading platforms and such trades are settled within 2 days. A forward trade is a settlement made in advance for a specific date and time with a specific amount of forex.   For a successful forex trading experience, there are other factors like fundamental and technical analyses that a trader must go through incisively. Otherwise, forex trading will remain a tough investment option to master with all its vagaries and volatility. 

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