The word forex refers to the ability to buy and sell a currency in exchange for another. It stands for foreign exchange. Forex is one of the markets in the world that is traded heavily on a daily basis.
A lot of people, businesses as well as countries are directly involved in the trading of forex. Therefore, when you are about to go on vacation to Europe and you trade your US dollars to euro, you are participating in foreign exchange.
When there is more of a demand for a particular currency, that demand will push the value of that currency either up or down in relation to other currencies. Before you can trade in currencies though, here are a few things you ought to know first, in order to be able to take the first step and start.
First thing to learn about forex trading are currency pairs and what they mean.
Currencies always trade in pairs in the forex market, meaning that there are always two currencies involved in a transaction eg. when you trade euros for dollars. Currency pairs are used so that one can clearly see the cost of one currency in comparison to another.
Symbols are used in the forex market to show specific currency pairs. The US dollar is designated by USD, the euro by EUR and the and the British pound by GBP. Thus, when talking about the pound/us dollar pair, we designate it as GBP/US. Other currency symbols also commonly traded are the Japanese yen=JPY, British pound=GBP, Swiss franc=CHF, Canadian dollar=CAD, New Zealand dollar=NZD, Japanese yen=JPY and Australian dollar=AUD.
Each one of these currency pairs have a market price associated with it. The price quoted on a currency pair indicates how much of the second currency eg. USD/JPY (in this case it is JPY) is needed to buy 1 unit of the first currency (in this case USD). For example, if the price quoted for EUR/USD is 1.4215, it means that it costs 1.4215 US dollar to buy 1 unit of euro.
If you’d like to know how much euro you need to buy 1 US dollar all you need to do is flip the pair to USD/EUR. Thus, you would need to divide 1/1.4215. The result in this case will be 0.7034. It would cost 0.7034 euros to buy 1 US dollar, based on that market price.
Market Pricing: A Quick Overview
When learning about forex trading as a beginner it is important that you learn new terminology teaching you about the price of currency pairs. Understanding how these terminologies fit not each other and how to use them to calculate profitable trades helps you get one step closer to your first currency trade.
In general currency pairs would move about 50 to 100 pips per day. The word pip stands for point in percentage, indicates the fourth decimal place in most currency pairs. In the case of the JPY currency, the second place.
If the price of a currency pair moves 50 pips it would as an example move from 1.4500 to 1.4550. Thus, if you bought at 1.4500 and sold at 1.4550, you would have made a profit of 50 pips.
The profit you would have made on the abovementioned trade also depends on how much currency you purchased. Buying a micro lot, which is 1,000 units, would only give you a 10 cents value on each pip, which means that your profit would be 50 pips * 0.10 = $5.
If you bought a mini lot, which is equal to 10,000 units, each pip would be worth a dollar. Your overall profit would have been $50. If you bought a standard lot, which is equal to 100,000 units, each pip would be worth $10, making your profit $500.
The value of each pip is called the “pip value”. Anytime you are dealing with a pair where the US dollar is listed second, then the pip values mentioned above apply. Whenever the US dollar is mentioned first, the pip values may be different.
To find out what the pip value is for the USD/CHF for example, you would have to divide the normal pip value by the exchange rate of the USD/CHF at that particular time. So, if the USD/CHF trades at 0.9367, a micro lot would be worth $0.10/0.9367 = $0.1067. The JPY pairs, like the USD/JPY have the exact same process except you have to multiply by 100.
When trading the first currency of the pair is called the directional currency on the forex price chart. Should you pull up a chart of the EUR/USD and you see the price moving up, it simply means that the euro is gaining in relation to the US dollar and vice versa.
Shortening The Learning Curve
In order to truly learn about forex as a beginner, one has to experience the movement of prices in reality. To do so you would have to place trades with a demo account or fake money. Using a demo account means that there is no real risk imposed on you. A number of brokers offer you the ability to trade with these demo accounts, that work exactly the same as real live accounts.
Forex Market – The Final Word
It is important that you understand the concepts discussed above in order to have a firmer grasp on what is happening when a currency pair rises or fall. Doing a technical analysis and working out the maths involved in the difference in pips between two currency price points will help you determine what the possible profit potential is. You should also be careful when you choose your own forex broker.