Understanding Forex means looking at what causes two people to need to exchange currencies. At the heart of Forex is trading. Trading is a broad term which historically meant two people buying and selling something, sometimes for money, other times by exchanging goods. Often this meant having to buy something in a different currency. This lead to the need to exchange one currency for another. Currency trading means Forex trading, where market participants look to buy and sell a currency in the hope of profiting from it.
Trading Forex involves buying and selling one currency at the expense of another. Within currency trading these are referred to as currency pairs. The most popular currency pairs involve the following 4 currencies:
These pairs are sought after as they are liquid and derived from major world economies. The remaining currencies are spread between minors and exotics. Minors are currency pairs that do not include the US dollar. Examples include:
Exotics are smaller currencies which are less in demand and include:
Finally the Aussie, Kiwi and Canadian dollar are known as the ‘Comdolls’, due to their economies’ strength coming from exporting commodities.
The less important the currency, the less liquid it is, with the spread being wider (more expensive). Understanding Forex means appreciating some of its quirks: Some brokers will not offer prices on exotic currencies as the market for them is not big enough.
At first glance, Understanding Forex and how to trade is easy. You aim to buy a currency low and sell it higher for a profit. The complication comes from humans finding it difficult to stay disciplined and avoid trading on emotion. Discipline is boring and not following our impulses requires self-control. You will need both to trade successfully. A good FX trader emphasises risk management, patience and has a clear trading plan.
Currency trading is uncertain at the best of times, having a Forex trading plan will help you mitigate emotionally driven undisciplined mistakes. Learning to accept making mistakes will help you understand Forex better, turning you into a consistently profitable Forex trader.
For those looking for extra income we recommend placing trades in the evening when the market has settled down. As you are trading using a risk-reward ratio and stop losses, you can be confident that you are protected from any adverse trading movements. This approach of ‘set and forget’, will ensure you can let your trades play out while getting a good night’s sleep! Forgetting about your Forex trades is often the best way of allowing them to turn profitable, understanding Forex means appreciating how too much interference can be counter-productive.
Trading is a simple act of paying out something (usually money) to receive something in return. This is usually some form of product or service. Forex market trading involves buying something uncertain. You don’t actually know what you are buying, you think you do. You’ve traded in the belief that you are going to make a profit. Realising that trading is an abstract action, will give you the ability to detach yourself. A trade which creates a loss will be seen as a learning opportunity. This Psychology will ensure you approach this contract with uncertainty in a cold calculated fashion.
Understanding Forex involves understanding what can move Forex prices. Any new retail Forex trader will soon learn how important central banks and government economic policy are on currency trading.
If a central bank raises interest rates, such as the New York fed is at the moment, then a currency becomes increasingly attractive. After a succession of rate increases the USD is now yielding more than any other major currency. This makes the US dollar more attractive to hold both for its yield, but also because of the possibility of increased rate hikes which will drive its value higher.
Government economic policy such as a vote to leave an economic union (think Brexit) can have a violent intraday reaction (sterling on 23rd June 2016). A more regular occurrence is the US non-farm payrolls which tracks the number of newly created jobs in the previous month. This influences the USD as it is seen as one of the best indications of the US economy’s further growth or contraction.
Understanding Forex means learning about currencies, what drives their prices, some awareness of economics but above all, an ability to learn from mistakes. Forex trading is not for the faint-hearted but with a clear trading strategy and a risk-based approach there is no reason why you can’t succeed!