Foreign exchange trading is about trading global currencies against one another and speculating on each currency’s appreciation or depreciation against its counterparts.
Investors can begin trading Forex relatively easily
For instance, if a trader believes that the currency of the eurozone (the euro) will depreciate when compared with the currency of the United States (the dollar) that trader has a bearish outlook on the EUR/USD currency pair and will want to express that opinion by taking a short position in the pair.
The value of each individual currency is relative to other currencies. The euro, for example, only has value if compared to the relative value of another currency, like the US dollar. Therefore, currencies are always traded in pairs, as opposed to individually, so traders must always consider at least two currencies when trading in the foreign exchange (or Forex) market.
In each pair, the first currency in the pair is called the base currency. The second currency in the pair is called the quote currency. When the current price of EUR/USD, for example, is quoted at an exchange rate of 1.3000, this means that 1.3000 of the quote currency (USD in this example) is equal to 1 of the base currency (EUR in this example).
Likewise, an exchange rate quote of 80.00 for USD/JPY means that 80.00 Japanese Yen is the equivalent of 1 US dollar. Buying (or going long) a currency pair is the same as buying the base currency while simultaneously selling short the quote currency. By the same token, selling short a currency pair is the same as selling short the base currency while simultaneously buying the quote currency.
Currencies in the Forex market change in relative value because of supply and demand forces. If there is more demand for a currency than there is supply at a certain exchange rate, that currency will appreciate in value. Conversely, if there is more supply for a currency than there is demand at a certain exchange rate, that currency will depreciate in value.
Supply and demand forces in the Forex market are determined by a wide array of global macroeconomic, business, and political factors that cause changes in market perception and subsequent flows from one currency to another, and vice versa. Some of the most important factors include interest rates, inflation, GDP, trade balances, employment situations, Central Bank policies, major financial market health, and even day-to-day currency exchange transactions by multinational corporations. There is a fundamental reason for all currency exchange rate fluctuations. But the specific reason or reasons for any given exchange rate change is not always clear.
Traders who trade based on global macroeconomic and political factors are considered fundamental traders. These traders attempt to analyse how the state of a country’s economy and political landscape may affect the value of its currency. They then take positions based on these analyses.
Another primary approach to trading Forex besides fundamental analysis is technical analysis. Technical analysis comprises a set of trading tools and techniques used by professional traders with the intent of drawing informed conclusions on potential future price movement. This is done using past price patterns and mathematical indicators.
The primary platform for employing technical analysis tactics in the forex market is the currency price chart. These exchange rate charts show historical price patterns that can be used to help predict potential price events in the future. Currencies are often highly trending, whether to the upside or to the downside, and technical analysis takes advantage of this fact to produce signals to buy and sell currency pairs.
Some key technical analysis tools and techniques include trend, support/resistance, chart patterns, moving averages, indicators/oscillators, Fibonacci, and candlestick patterns.
Investors can begin trading Forex relatively easily and with a limited initial investment. Starting with a free practice account, beginning traders can test their market views and trading strategies without risk, and then gradually move onto live trading with actual funds as they increase their skills and confidence. Forex trading has quickly become an exciting investment asset class that carries many advantages over other asset classes.
High risk warning
Foreign exchange trading carries a high level of risk that may not be suitable for all investors. Leverage creates additional risk and loss exposure. Before you decide to trade foreign exchange, carefully consider your investment objectives, experience level, and risk tolerance. You could lose some or all of your initial investment. Do not invest money that you cannot afford to lose. Educate yourself on the risks associated with foreign exchange trading, and seek advice from an independent financial or tax advisor if you have any questions.