Forex Basics 1 – What is Forex
What is Forex?
Foreign Exchange, also known as forex — is the exchange of two currencies at an agreed price, on a decentralised global market where all the world’s currencies are traded. It is the largest market in the world with nearly $6 trillion (6, 000,000,000,000) in average daily trade volume. The traders on this market may be central banks, commercial banks, multi-national companies, financial institutions, hedge funds, money changes, speculators or forex traders.
How does it create profit?
For example, when you are travelling overseas, you will need to convert your money to the destination’s national currency. You create the demand for two-currencies exchange and the local money changer supplies you with the desired currency, at an exchange rate set by banks or liquidity providers (based on global supply & demand).
The exchange rate will create a small difference in monetary value, allowing the money changer to generate profit. It seems small for individual traders, but for multi-national corporations or financial institutions dealing with millions in transactions, it adds up to a big figure, this is where the banks, money changer and liquidity provider earn from, called “spreads”.
Due to the fact that currency rates are based on global supply and demand, it fluctuates continuously; changing your currency now can be a big difference than changing your currency later. This is where forex traders earn their profit from.
Earning from forex trends?
Forex differs from stocks where you can only profit from the price going up, in forex you can trade both up and down based on what trend the currency is heading to. If you predict a currency will increase in value, you buy it at the lower price (open position), wait for it to appreciate, and then resell it at the higher price for profit (close position). Vice versa, if you think it will decrease in price, you can sell the currency now (open position), wait for it to depreciate, then close position for profit.
The longer the trend/ the further the closing price than your opening price, means a bigger profit (correct trend) or bigger loss (wrong trend). Additionally, unlike stocks or crypto trading where you need to wait for buyers to accept your orders, the forex market is so huge that almost all of your valid orders will get accepted and executed.
The ultimate purpose of forex trading is to identify the correct trend of the markets, open and close positions when it is profitable.
All forex transactions are performed in pairs of currencies, formed by a base currency and a quote currency. For example, one of the most traded currency pairs is EUR/USD, which means the Euro is the base currency and the US Dollar as the quote currency. The exchange rate is 1.1068 which means that one Euro is equivalent to 1.1068 US Dollars.
This rate further differs into buying (ask) and selling (bid) price. The ask price is the value which the trader accepts to buy the currency from you; the bid price is the value which the trader accepts to sell the currency to you.
* These forex rates are quoted in 4 decimal places, each value difference is called “pips”, such as 1.1070 is 2 pips difference from 1.1068.
** The pips difference between ask and bid price is the “spreads”