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What is forex and why do we trade forex?

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Forex trading
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Lesson 1

Out of many different types of investing and speculative instruments, the foreign exchange market, or forex, is one of the most popular. Traded over the counter, unlike stocks or other exchange-traded or centralized products, the forex market comes with significant benefits.

You can start trading forex risk-free with a $10,000 demo account at a regulated broker.

The forex markets are open longer than most other markets because the instruments can be traded throughout the day. As you know, the currency markets span different time zones, and when New York closes, Sydney opens. Except for weekends, when the global markets are closed, the forex markets are open literally 24 hours a day.

The Bank for International Settlements (BIS) puts the average daily turnover in the forex markets at over $4 trillion, making it one of the most active and largest markets available for speculators and investors.

If you want to be successful in trading forex, then it is important to understand the forex markets, which this article aims to teach you.

What is the forex market?

The foreign exchange, or forex, market deals with currencies. Unlike stocks, where a single instrument is traded, the forex market deals with currency pairs. Investors and speculators trade the forex market for a number of reasons: from hedging their currency exposures to merely taking advantage of the price fluctuations in the market.

Even small traders can start to trade forex, thanks to the leverage opportunities. Traders can trade with just $100 and use the leverage to maximize their potential. This is one reason why forex is widely preferred over other markets. The over-the-counter nature of the market makes it free from regulations and allows traders to capitalize on the price movements of the currencies.

As the name suggests, the forex market deals with currencies and their price movements. Since the end of Bretton Woods and the death of the gold standard, most of the advanced economies have moved to a free-floating exchange rate. As a result, the currencies’ prices are set by the markets to a certain extent.

If the markets see value in a currency, based on a number of factors, such as economic development, political stability, and interest rates, the currency is more preferred and thus speculators buy the currency and sell a weaker currency.

Who is trading forex (The Market Players)

The forex markets are primarily dominated by the interbank markets. The large institutional banks play a major role in the daily volumes. Because banks deal with currencies on a daily basis, the exchange of one currency for another takes place every second.

Almost any transaction conducted goes through a bank. Therefore, some of the largest banks are the biggest players in the forex markets. The retail forex trading sector is, in fact, a small drop in the ocean when it comes to the market share.

The banks are responsible for not just processing the transactions but also making use of a variety of tools to place their own hedges against any exposure they might have. The banks’ hedges are usually speculative in nature.

In addition to the large institutional banks, on rare occasions, central banks are active participants. The central bank participants are, however, only those nations that have a fixed range exchange rate band. For example, in 2015, the Swiss National Bank abandoned its fixed exchange rate of 1.20CHF to the euro.

Until then, the Swiss National Bank was vigorously trading in the forex markets to defend the 1.20CHF floor against the euro.

Forex trading sessions

The forex market, as you know, operates 24 hours a day, which is made possible through the various trading sessions. The forex markets are unique because they are truly global.

For example, the American stock exchange works during the U.S. business hours, while a Tokyo stock market operates during the business hours in Japan. When it comes to forex, the markets are alive and active throughout the day.

The forex trading sessions are broadly classified into the following: Asian, European, and US.

The Asian trading session starts with Sydney, Australia and overlaps an hour later with the Tokyo markets. Later in the day, the Australian markets are closed, while the Japanese trading session overlaps with the start of the European trading session.

Following this overlap, after a few hours, the European session progresses and eventually overlaps with the North American or the U.S. trading session for a few hours.

Finally, at close of business in Europe, the U.S. trading session progresses, then overlaps with Sydney.

Although the forex markets are alive 24 hours a day, volumes are higher during the European/Japanese sessions and the U.S. and European market overlaps.

In terms of GMT, the forex trading sessions are as follows:

  • Sydney 22:00 GMT - 07:00 GMT
  • Tokyo 23:00 GMT - 09:00 GMT
  • London 08:00 GMT - 17:00 GMT
  • New York 13:00 GMT - 22:00 GMT

Therefore, traders from anywhere in the world can comfortably access and trade in the forex markets. This has also been made easy by the numerous retail forex brokerages, which allow individuals to trade effortlessly.

Advantages of trading forex

Trading forex obviously has quite a few benefits, which clearly outweigh other markets. Here are three of the main advantages of trading forex.

Low capital requirements: While trading stocks requires you to have a significant amount of capital, with forex, you can get started for as little as $100. Some forex brokerages allow you to even trade for $5, but don’t expect to get rich by trading with $5.

Leverage: Leverage is one of the keys that makes forex tick. Starting with 1:10 leverage, you can go as high as 1:200, allowing you to magnify your positions when trading forex. Leverage is risky, however, and traders should always be cautious. Your losses will also be as large as your profits.

24-hour market: The forex markets are open 24 hours a day, making it one of the most widely accessible markets in the world. Traders from anywhere can access the forex markets. This ease of accessibility, combined with the low capital requirements and leverage, makes it an ideal market to trade in.

Although trading forex looks easy and quite accessible, traders should remember one can easily lose all his or her investment due to the risky nature of the forex markets. Furthermore, the volatility in the currency markets is not suited to all investment profiles. Therefore, it is always in a trader’s best interest to consult with his or her personal financial advisor.

Even if you just want to speculate in the forex markets, always remember your losses can quickly pile up. While risk is an ever-existing factor in any investing or speculative markets, with a bit of effort and understanding how the forex markets work, one can aim to be consistently profitable and make a living trading forex.