This introduction explains the basics of online trading with currency pairs (Forex trading), gives a brief explanation of the markets and shows the major benefits of online Forex trading.
Forex (Foreign Exchange) and abbreviated FX are terms that describe the trade of foreign currencies. The Forex trading market is the largest market worldwide. The global trading volume sums up to over 4 trillion U.S. dollars a day. Most transactions in the Forex market are speculative ones. Only a small part of the market activity is done by representatives of governments and of enterprises which need foreign currencies for their day-to-day business activities.
In contrast to trading stocks, the Forex market is not operated by a central exchange, but bases on the “interbank” market, a so-called OTC (over the counter) market. Trading takes place directly between the two trading parties. The main centers for Forex trading are New York, London, Frankfurt and Tokyo.
Forex Trading – Trading Foreign Currencies
Exchanging foreign currencies means buying one currency and selling another currency simultaneously. The two currencies involved are referred to as a currency pair. The major foreign currency pairs are the U.S. dollar to Euro, U.S. dollar to Yen, U.S. dollars to British pounds, U.S. dollars to Australian dollars and U.S. dollars to Swiss francs.
U.S. dollar to Euro, Yen and British pounds account for far more than 50% of the global foreign exchange volume.
Trading with Leverage (Margin)
Because the currency fluctuations are small in the short-term, currency pairs can be traded on credit with a small margin. This means that you can trade currencies with a high leverage, typically 200:1 or even 400:1. A leverage of 200:1 means that you simply have to deposit a margin of 1 / 200 = 0.5% of the value of the currency pair you want to trade. So with $ 1,000 and a leverage of 200:1, you can take control of $ 200,000. If you buy Euro and sell USD at the same time, you speculate that the Euro will increase compared to the USD. If the Euro increases by only 1%, then the value of your invested $ 1,000 has tripled, leaving you with a net profit of $ 2,000. Conversely, there is also the margin call: if the value of the Euro decreases by half a percent, then your position is no longer covered by your margin deposit of $1,000: the Forex broker software will usually liquidate the position automatically in order to prevent you from losing more than the invested $ 1,000.
Benefits of Forex Trading
Compared to trading stocks, FX trading has some major benefits:
Trading around the clock: in contrast to trading stocks, currency pairs can be traded around the clock. So you can earn money with FX trading during that time of the day (or night) which best suits you.
Liquidity: because the FX market is the largest market in the world, it is extremely liquid. The spread, the difference between the buying and selling rate (bid and ask price) is therefore very low. And the lower the spread is, the lower the costs of a transaction are.
No commissions: opposed to tradings stocks, you can trade foreign currencies without having to pay a commission. Forex brokers earn money by offering different exchange rates to buyers and sellers. You do not have to pay a commission for each trade, nor do you have to pay other fees such as custodian fees.
Leverage: with a leverage of up to 1:400, you can move huge sums of money with only small investments. Please note that your risk is greater the higher the leverage is, which might result in a total loss of your invested capital.
Make money in falling markets: When you buy shares you hope that the stock price will rise. If you want to profit from falling stock prices, you have to resort to other instruments such as buying put options. While trading currencies, you can profit both from rising and falling exchange rates. If you think for example that the Dollar will increase against the Euro, then you buy USD and sell Euro. If you think that the USD will decrease compared to the Euro, then you buy Euros and sell US-Dollars. And even if a currency pair is relatively stable, you will notice small fluctuations in the exchange rate from one minute to the next minute. Using leverage, you can profit from these small intraday movements – provided you choose the right currency pair for your trades.
Dive into the fascinating world of online Forex trading now! Select a broker from our Forex broker comparison table, and start trading online. We recommend you to gain experience with a free demo account first before depositing and risking your own money.