Forex Trading: Investing Basics

The world’s largest financial market, which has a big role in the world’s economy, is the foreign exchange also known as the forex market. Each day an average of around $5 trillion is exchanged from one currency to another. This type of currency exchange is crucial for international business. Common participants in the forex market trading are governments, businesses, and investors.

Governments use the forex market to apply policies. For example, when a government is doing business with another country, whether it is offering aid, lending or borrowing money that particular government has to convert its currency into a foreign currency.

Investors use the forex market to speculate on price changes of the currencies. These prices change almost constantly during the week since the forex market is open from Sunday at 4:00 PM until Friday at 4:00 PM central time.

Businesses, on the other hand, use the forex market to make international trade easier.

Before proceeding to how the forex market trading works it is very important to be familiar with cfd (Contract for difference) trading.

Contract for Difference Trading (CFD)

CFD trading allows you to trade on the price movements of any financial market such as commodities, indices, stocks, and currencies without actually owning them. If the price of a certain asset goes up after buying a CFD, the rise of the asset will be beneficial for the investor. This is called “going long”. If, on the other hand, if a CFD is bought and the particular asset goes down, the investor can profit by selling the CFD. This is called going short.

How Does Forex Trading Work?

When you trade currency using the forex market instead of trading one product, you are trading two currencies against each other. This is also known as a currency pair. Although there are two currencies involved, the pair itself is a single entity. This is similar to a stock or a commodity. Investors profit when they buy a CFD for a currency pair with an increasing price. Also, investors will profit if they sell or short a currency pair and the price decreases.

Vital Elements of The Forex Market

Margin

When trading with margin, you will only need to put up a percentage of the total investment to enter into a position. This is called a margin requirement. When you trade other assets like stocks, trading with margin basically means that you are borrowing funds from your broker. In contrast, forex trades can only be done if the investor transfers funds beforehand in their forex account. This means he does not have the option to enter a forex trade by borrowing money from their broker. Forex margin requirements depend on the currency pairs and the size of a trade.

Leverage

Leverage is the second key element of forex trading. It allows investors to have control over large investments with a small amount of money. While the leverage that is associated with currency pairs is one of the benefits of the foreign exchange it also may be a risk. With leverage, investors can make large profits or large losses.

Financing

The third important element in the forex market, financing, is the calculation of net interest owed or earned on currency pairs. The financing happens when the investor holds their position after the trading day is over.

Keep in mind that when you trade a currency pair, you are trading two currencies against each other. Despite the fact that the currency pair acts as a single entity, you are actually short one currency and long the other. With financing, on the other hand, you are lending the currency that you are long and borrowing the currency that you are short.

The lending and borrowing trigger the overnight lending rate of each currency. An investor only receives credit if the currency he has long had a higher interest rate than the other currency. On the contrary, the investor is in debt if the currency he is long has a lower interest rate than the currency he is short.

Conclusion

With all investment opportunities, the forex market has its own risks and benefits, and therefore gathering knowledge on the forex market and its elements would be the first step for you to consider before starting.

This article does not necessarily reflect the opinions of the editors or management of EconoTimes