WHAT IS FOREX TRADING AND HOW IT ACTUALLY FUNCTIONS

Forex is nothing but the short form of ‘Foreign Exchange’. In olden days, people used to exchange their currency for the purpose of trade with foreign countries. And, sometimes, while travelling to another country for any reason. They used to exchange their home country currency with the currency of the country they are going to visit /stay, for the purpose of expenses over there.

But, the current situation is different. We can now exchange different currencies on the ‘Over- The-Counter market’, for the purpose of gains at the rate of speculating the currency rates against the dollar ($). All this trade takes place in the form exchange of one currency for  the other at an agreed exchange rate. Of course, on the ‘Over-The-Counter’ (OTC) market.

Best Ever In The History

In reality the world’s most traded market is nothing but the FOREX /Foreign Exchange Market. According to the Triennial Survey 2016, the Global Turnover of FX markets stood at $5.1 Trillion. Actually, this is down from $5.4 Trillion in April 2013.. This can be considered as the best ever turnover in the FX Market till now. This was happening due to the more aggressive and heightened activity by the traders. The trading currency was Japanese YEN against the background of Monetary Policy developments at that time.

Weekends And Holidays

Even though Forex Markets are considered to be ‘the all time markets’, the actual truth is something different. This market too has a Weekends and Holidays. One could not avail the full services offered by the Banks and Brokers on these days. Hence, one can see the low liquidity in the market. But, the market opens on a high note, in terms of trading activity by the traders.

No Physical Location

Forex Marke doesn’t have any physical location. Unlike most financial markets this over the counter market doesn’t have any Central Exchange too. But, trades take place at a 24 hours a day, through a global network of Banks, Businesses and Individuals. The trade continues due to fluctuation in the prices of different currencies against each other, offering multiple trading opportunities.

24 Hours A Day Market

Sunday evening to Friday night. 24 hours a day, Forex Markets are open. Of course the key aspect of their popularity.

Forex
TRADE ANYWHERE, ANYTIME AROUND THE GLOBE – FOREX

The trading follows the clock to move around the globe, active in different time zones and in different time frames. Starting from Wellington and New Zealand  on Monday morning, progresses towards Asia. Then spearheaded out of Tokyo and Singapore moves towards London to close in New York on Friday.

Price Fluctuations – Volatility

Currency values of different countries rise and fall against each other a lot. These fluctuations in prices are influenced by  Geo Socio, Economic and Political factors. Forex markets respond so quickly and aggressively to any of these factors, including News and Events. Thus, creating plenty of trading opportunities for the  traders. That’s what makes the Forex Trading so interesting and exciting.

Some of the Key- Factors that may influence the Forex prices are.

  • Monetary Policies
  • Currency Intervention
  • Political and Economic Stability
  • Natural Disasters

Leveraged Product

Forex Trading is required to deposit only a small percentage of the full value of the position. Hence, unlike any traditional trading, the potential loss and profit is higher in Forex trading, from an initial capital outlay.

Key Forex Terminology

Price Gapping

When the price jumps from one level to the other without any trading in between, the Price Gapping occurs. This usually happens in other Financial Markets. But, in Forex trading, there is no such price gapping, as traders can take positions whenever they want and also can exit. There are no time boundaries. And, the markets are open for ‘24 hours.

But, there are ‘Lull’ times. During these hours the volumes are extremely low, below their daily average. This usually creates a ‘Wide Spread’, which can be normalized once the trade resumes.

Base And Counter Currency

Forex trading panel shows, pair of currencies to choose between.

A Screen Shot of Forex Market Index

In the above Forex Index Screen, the first currency pair is EUR/USD. And, it’s shown that the Euro is less in value by 1.06138 points. Or in other words, US Dollar gained by the same number of points. The low of Euro (1.06100) and a High of Dollar (1.06149) is also shown.

Spread

Spread is nothing but, the difference between the BID and ASK price of the currency pairs.

For example, consider a pair GPB /USD. If the GBP is 1.1535 times the USD, the ASK will not be exactly 1.1535, but it will be a little bit more, say 1.1537. And, the BID will be lesser than 1.1535, say 1.1533. Here the spread is the difference between the ASK and BID prices.

Therefore Spread = (ASK – BID)

i.e (1.1537 – 1.1533) = 0.0004

And, this SPREAD goes to the Specialist who facilitates the trade.

Pips

Usually, the currency pairs are quoted to 5 decimal points (0.0001), except the Japanese Yen. The yen is displayed only to two decimal places /points (0.01). The price change is from the fourth decimal place.

A PIP stands for ‘Point in Percentage, measures the amount of change in the exchange rate for a currency pair. In order to provide extra digit of precision, when quoting exchange rates for certain currency pairs. This is called a fractional PIP, which is equivalent to 1/10th of a PIP.

Example: Let’s consider a trade in a pair USD/CAD. If the trade amount is $ 200,000. And, the trade closed at 1.0346, after gaining 10 pips. Calculate, the amount of profit gained in USD.

1 PIP = 0.0001

The total amount of trade in terms of CAD = (200,000) × (0.0001) = 20 CAD

No. of USD per PIP = (20) ÷ (1.0346) = 19.33

The total loss /profit for the trade = (10) × (19.33) = 193.30 USD profit

Hence PIP tells about the Percentage of Points Gained / Lost.

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Hameeda Ghori

Certified Financial Planner And Stock Analyst

2 thoughts on “WHAT IS FOREX TRADING AND HOW IT ACTUALLY FUNCTIONS

  • May 4, 2017 at 3:40 PM
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  • May 4, 2017 at 2:41 PM
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