Currency trading is the rate at which one currency will be exchanged for another. It is also known as the value of one country’s currency in terms of another currency. The Foreign Exchange (also known as Forex or FX) is the market that allows you to trade currencies in volume. A currency trader – whether a corporation, an individual, or bank must be skilled and acquainted in the way the Forex market works by monitoring and acting on the subtle changes that indicate the potential for profit.
A typical scenario goes like this: An interbank exchange rate of 81 Japanese yen (JPY, ¥) to the United States dollar (US$) means that ¥81 will be exchanged for each US$1 or US$1 will be exchanged for each ¥81. The currency exchange rate is usually quoted in pairs like USD/EUR (the US Dollar and the Euro). Also, fluctuation of exchange rates is based on economic factors like industrial production, inflation, economic busts or booms, geopolitical events, or even natural disasters. These factors will affect whether you buy or sell a currency pair.
Whether you are a Forex novice or you need a course to refresh your understanding on the basics of currency trading, keep reading to find the answers to the most commonly asked questions about Forex market.
Why Trade Currencies?
Forex is the world’s biggest financial market, with about 3.6 trillion US dollars traded each day. Although it is dominated by corporations, big banks and private investment funds, the retail segment is still the fastest-growing, according to Bank for International Settlements. In 2010, daily retail volume was $313 billion, up from $300 million in 2000, according to Boston-based research firm Aite Group LLC – which estimates volume will continue to rise as the years go by.
Is Currency Trading Risky?
Although the Foreign Exchange market has luring record numbers of real investors, the potential pitfalls are huge. Forex used to be even riskier. Yes, currency trading can be very risky because currencies tend to be very volatile when compared to other markets.
The Forex market can change direction at a moment’s notice, depending on conditions within that country. However, the major key to success with currency trading is to make use of conservative risk management as there are a lot of components to effective currency risk management. The bottom line still remains: “use caution” and “have a trading plan.”
What is a Pip?
Pip is an acronym for ‘percentage in point.’ It is the smallest increment of trade in foreign exchange. Prices are usually quoted in the 4th decimal point. Example: if an item in a store was priced at $2.40, in the forex market, the same item would be quoted at 2.4000. That change that occurs in the 4th decimal point is what is called one pip and it is equal to 1/100th of 1%.
How Does the Forex Market Differ From Other Markets?
Unlike stocks, opinions or futures, currency trading doesn’t take place on a regulated exchange. This is because no central governing body controls it, no clearing houses to guarantee the trades and no arbitration panel for adjudicating disputes. Trade between members is based on credit agreements. Some of the differences between Forex and Equities markets include:
* 24 hour trading. Which means you decide whenever you want to trade or how to do it
* It is easily accessible. Meaning you do not need too much start-up capital
* A lot of firms do not charge commissions. You only pay bid/ask spreads
* You are allowed to trade on leverage. Meaning you can increase potential gains with potential losses
* Instead of buying thousands of stocks, in FX you can just focus on choosing few currencies
Is Currency Trading for Everyone?
One major benefit of trading currencies is the high leverage. This is also one of the pitfalls. Consider your objectives for investing before deciding to trade Forex. Also, your risk appetite and level of experience are other things that should be considered. Feel free to seek advice from a financial advisor that is independent in case of any doubt.
Common Currencies Traded in Forex Market and Commodity Pairs
The major currency pairs traded in Forex include:
* USD/EUR (Dollar/Euro)
* JPY/USD (Japanese Yen/ US Dollar)
* GBP/USD (British Pound/US Dollar)
* CHF/USD (Swiss Franc/US Dollar)
The 3 commodity pairs include:
* USD/AUD (US Dollar/ Australian Dollar)
* CAD/USD (Canadian Dollar/US Dollar)
* NZD/USD (New Zealand Dollar/ US Dollar)
Common Terms Used in the Forex Market
* Pound, sterling, cable – other names used for the GBP
* Buck, Greenback – nicknames for the U.S dollar
* Swissie – another name for Swiss franc
* Yard – Means “I sold a couple of yards of sterling”, or a billion units
* The little dollar, Lonnie – nicknames for the Canadian dollar
* Aussie – Nickname for the AUD or Australian dollar
* Figure – Forex term connoting a round number like 1.3000
* Kiwi – Another name for the NZD or New Zealand dollar