Learn all about the fundamentals of forex trading here. From the reasons and the ways to trade forex, to trading on leverage and margins, get a good understanding of the basics before you start trading.
A simple way to understand the forex market is to think of it as changing money when you travel abroad. When you change money, you sell one currency and buy another at the current exchange rate. This is because the value of your own currency is not equal to the value of the currency you wish to buy. In effect, you have traded currency and this is very similar to forex trading.
Currencies constantly need to be exchanged in order to conduct business and ensure there is trade between countries. This makes the spot forex market one of the largest, most liquid financial markets in the world. To put this into context, the daily volume of trades on the London Stock Exchange is $7 billion, whereas the daily volume on the spot forex market is more than $4 trillion.
Unlike other financial markets, such as stocks or commodities, the forex market has no central location or exchange. The market is so large that it’s unlikely to be affected by one person or one company – it takes much bigger processes to influence the direction of the market.
In simple terms, it’s the simultaneous buying of one currency and the selling of another. When you trade forex, you can trade with a broker through a trading platform.
Currencies are always traded in pairs, for example GBPUSD (trading the British pound against the US dollar). The first currency in the pair is known as the ‘base’ currency, the second one is the ‘quote’ currency. They are also often referred to as ’buy’ and ‘sell’ or ‘offer’ and ‘bid’. A GBPUSD price of 1.55311 means that 1GBP buys you USD1.55311.
All currencies are traded in pairs and each currency has an official abbreviation, for example GBP for British pound, USD for US dollar and EUR for the euro.
The ‘base currency’ is the first currency in the pair and the ‘quote currency’ is the second currency. These are commonly referred to as the bid and ask price.
You can trade currencies because the values of currencies change. The exchange rate tells you how much of one currency you need to pay to buy one unit of another. In forex trading, exchange rates are displayed as the bid and ask price for a currency pair.
The difference between the bid and the ask price is known as the spread and it's how your broker generates much of its revenue. Spreads can vary from broker to broker, so look out for tight spreads in order to minimise your trading costs and maximise your profits.
It’s important for you to understand how spreads are measured. For example, if GBPUSD has a bid price of 1.55310 and an ask price of 1.55313, the spread is 0.3 pips.
When you trade forex, you’re buying one currency and selling another at the same time, which means you can speculate on rising and falling markets. This is one of the major advantages of forex trading.
You are likely to hear forex traders talk about bullish and bearish markets. When a market is rising or believed to be about to rise we call it ‘bullish’; when it’s falling or believed to be about to fall, it’s called ‘bearish’.
First of all, consider whether the currency you wish to trade is likely to rise or fall. This forms the basis of your trading strategy.
In a buy position, you believe that the value of the base currency, in our example the Euro, will rise against the quote currency, the US dollar.
Let’s assume the price of the EURUSD is 1.30722 on the bid price and 1.30742 on the ask price. Therefore, the spread is two pips. When you buy, your trade is entered at the ask price of 1.30742.
Later you decide to close your trade and the bid price of the EURUSD pair is 1.30762 and the ask price is 1.30742. Your trade has gained 2 pips. If each pip were worth one US dollar, you would have made a 2USD profit.
Now let's bring the same example and see what happens with a sell position. You believe that the value of the base currency will fall against the quote currency. Using the same example, this means you believe the price of the Euro will weaken against the US dollar.
The current value of the EURUSD pair is 1.30742 on the bid price and 1.30762 on the ask price. As you’re selling, your trade is entered at the bid price of 1.30742.
Later in the day, you look at the position and the EURUSD is now at 1.30702 on the bid price and 1.30722 on the ask price. You decide to close your position at the current price of 1.30722. Your trade has gained 2 pips. If each pip were worth one US dollar, you would have made a 2USD profit.
The spot forex market is the most liquid market with a daily volume of more than $4 trillion. Liquidity is one of the main reasons why people trade forex. Equiti are not active in the spot forex market, but have the necessary permissions from the JSC to allow their clients to be active in the rolling spot forex market (or rolling spot forex market).
The forex market runs 24 hours a day, 5 days a week, because at any given time of the day or night the market is open somewhere in the world. That means you can trade whenever you want, from anywhere in the world.
One of the reasons to trade forex is that you can find opportunities in both rising and falling markets – you can trade when you believe the price of the currency pair is going up, or when you think it’s going down. If you think the price is going up, you buy, and if you think it’s going down, you sell.
Sometimes you can observe periods of volatility when a market opens or closes. That means that the prices can change very quickly and unexpectedly. High volatility can create trading opportunities, but it also increases risks.
If you’re asking yourself, why trade forex, the answer is simple – you can find great opportunities in the forex markets. If you’re interested in the world of business and you keep up with the latest news, then forex could be your ideal market to make your moves.
Your ability to borrow money from your broker to trade currencies is what leverage and margin are all about in forex. With leverage you can increase your ‘trading power’ – giving you more money to trade with than your deposit. Before you enter a leverage or margin trade, make sure you understand how it works so you can make the most of your trading while calculating your risk.
One of the most powerful tools in forex trading is leverage. Using leverage means that if, for example, you want to make a $100,000 deal, and with a 1:200 leverage you would need a deposit of only $500. High leverage can make the forex market highly profitable though very risky.
Essentially, the aim of trading on margin is to magnify profits by being able to take out larger positions than you would be able to with your money alone. However, this also increases your risk. It’s important to remember that you can lose more than your initial stake.
To show you how it works, let's look at the process of buying a house. You have a deposit of GBP50.000 and the property costs GBP250.000, five times your deposit. You need to use your bank as leverage to be able to buy the house, so you apply for a mortgage that covers the remaining GBP200.000. The ratio – or your leverage – is 50,000:250,000. This is more commonly expressed as 1:5.
Before you start trading, you are required to put up a percentage of the money that you borrow ‘in good faith’. Let’s say you want to trade the EURUSD currency pair and the amount you want to invest in that position out of your own pocket is GBP2.000.
Your broker requires you to make a minimum deposit to hold this position. This initial deposit is your margin requirement. The value of your trade is much higher than this. When you trade with Equiti the value can be as much as 500 times your initial deposit. If you choose 1:10 leverage, your GBP2.000 would let you place trades up to the value of GBP20.000.
Now let’s say you want to trade 1 lot of GBPUSD with a leverage of 1:500. The equivalent of 1 lot is 100,000 units of the base currency (GBP). So in this example, the calculation is 100,000 units divided by the leverage of 500. This gives you the margin required for your trade, which is GBP200.
It’s important to remember that you should be careful and not over-leverage your position based on the equity in your account. Trading on margin and leverage can greatly increase your profits, but it can also magnify your losses very quickly if the markets move against you.
Your leverage check-list
If you trade forex on a ‘spot’ basis, all trades settle two business days from inception, as per market convention. The settlement date is referred to as the value date.
Equiti offers ‘rolling spot’ forex. This means we don't arrange physical delivery of currencies and therefore, all positions left open from 23:59:45 to 23:59:59 (MetaTrader time, EET) will be rolled over to a new value date. As a result, positions are subject to a swap charge or credit. Please read our rollover/interest policy to find out more.
The rollover cost is based on the interest rate differential of the two currencies. Let’s assume that the interest rates in the EU and USA are 4.25% and 3.5% per annum respectively. Every currency trade involves borrowing one currency to buy another. If you have a buy position of 1.0 lot in EURUSD, then you earn 4.25% on your euros and borrow US dollars at a rate of 3.5% per year.
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