The Basics Of Forex

Forex, also known as currency trading and the foreign exchange, is the market for trading currencies. Currencies are traded against each other in pairs and traders try to predict the strength of one currency against another.

for instance, in the EURUSD pair, traders would speculate on the movement of the EUR relative to the USD. If they expected the euro to rise, they would 'buy' the forex pari, and if they thought it would drop, they would 'sell'. Traders then make a profit or loss on the difference between the opening and closing prices of the forex trade.

The Basics Of Forex

Most forex trading is done with derivatives, or contracts representing a fixed amount of the currencies involved.

Generally, one contract is worth 100,000 units of the first-named currency. The size of these contracts enables you to profit on price movements even smaller than a cent. Price movements are measured in 'pips', or units of 0.0001 (so 0.01 of one penny), and each movement of 0.0001 is worth 10 of the second named currency. Consequently, one contract of the EURUSD represents 100,000 euros, and every pip movement would be worth 10 dollars.

For example, if the EURUSD was trading at 1.3768 and you thought it was going to rise, you could 'buy' one contract of the EURUSD. Then, for every pip the pair goes up you will make 10 dollars, and for every pip it drops you lose USD10.

One week the currency pair has risen to 1.3930 and you decide to sell and take your profit. The difference between your entry and closing price is 162 pips, which gives you a gross profit 1,620 dollars.

Forex trading has numerous advantages, such as:

24-hour trading - the forex market is open across three sessions around the world. These sessions stay open for 24 hours a day, 5 and a half days per week, allowing traders to trade at times that suit them.

Liquidity - the fx market is very liquid, which means that the trading spreads are often smaller than other markets, and it is also very easy to enter and exit positions on the major pairs.

Opportunities to profit - as currencies are always moving in relation to each other; it is possible to profit at any time.

No commissions - forex is often commission free. Traders just need to cross the trading spread, and pay no other commissions to trade.

However, it is important that a trader takes the time to research and decide upon a broker that offers transparent pricing information and is regulated by the local authority.

A second risk is the level of leverage traders can access - in the example above you traded a contract representing EUR100,000, and, depending on the broker, you might have been able to open this position with a deposit as low as 0.5% of the contract value, or 500 euros. Although this gearing allows traders to make large profits on very small price movements (the movement in price in the previous example was 1.62 cents), it also means they can make equally large losses on small price movements.

There are a number of ways to manage this risk, including setting automatic closing levels on your trades to reduce your losses in the event that the market moves against you, limiting the amount of capital you risk per trade, trading mini rather than standard contracts, having a trading strategy that outlines strict criteria for opening and exiting trades, and keeping up-to-date about the market. It is nearly impossible to make constant profits, having a trading system that incorporates your knowledge, risk management and trading criteria will increase the consistency of your profits.

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