FOREX in a nutshell
How many times did you hear the word “FOREX”, wondering what it actually means? Your search for answers is over. Below we have gathered all you need to understand about the essence of FOREX.
FOREX, aka FX, is the world’s biggest and most liquid financial market. To put it simply, this is a global market of currencies. FX has no physical location - it is spread all over the globe and operates electronically.
Originally it was an exchange between large banks, but in the nineties FOREX has gone retail. This became possible thanks to internet-based platforms streaming live currency quotes around-the-clock, 5 days a week. Since then, any individual (including you) can execute a profitable trade on FOREX.
What’s traded in FOREX?
It may sound like a paradox, but Forex traders are buying and selling money. In this market, currencies of different countries are considered as a commodity. The price of such a commodity is always defined in relative terms: one currency is valued against another – and the ratio will naturally be in favour of a healthier economy.
This is why currencies in FOREX are always traded in pairs, with prices coming as fractional numbers. An example: one of the most traded pair, the so called “major” is EUR/USD. If this pair is quoted at 1.18, it means that 1 euro can buy 1.18 dollars. However, the next moment this ratio may change – as it constantly happens in FOREX. And it is these fluctuations which become a source of earning for a trader.
How exactly do FX deals work?
The core of a trader’s business is making correct forecasts about currency dynamics. The routine goes like this: predict the price change – open a deal in the same direction – get your profit. However, if we look at the statistics, this seems a case of “easier said than done”. Only 5% of traders become successful, while the rest unlucky 95% make mistakes and lose money.
Quite a few methods exist to improve your odds at FOREX: technical and fundamental analysis, candlestick charts, indicators, Elliott waves, etc. We will shed some light on these in our next courses.
Explaining the earnings of a FX trader
Earnings in FOREX are made up by the difference between opening and closing prices of the trade. To open a position, you either buy or sell a certain currency pair, and do the opposite action when you close the trade.
Let’s do a little math to see how it works. Suppose you invested $1000 in EUR/USD, which is currently quoted at 1.18700. You believe that the euro will strengthen against the dollar, and so you buy EUR/USD (if you had an opposite opinion, you would sell). After a while – it could be minutes or days – the price indeed reaches 1.19008. If you close the trade at that point, you will receive a profit of 0.00308 pips.
One pip is a measurement unit for a minimal price change. It is the 5th decimal place of a quotation, and it has its own value. In our case the profit is calculated as follows: (0.00308 / 1.18700) х 1000$ = 2.59$
How do I open a FOREX deal?
Go to Olymp Trade Forex platform, and first, decide on the amount you are going to invest. Then choose a currency pair (also called asset) and forecast its quote dynamics. If you believe in the increase, you buy this asset, and vice versa – sell, if you think the quote will drop. A small commission, known to you in advance, will be charged.
There are some special tools in FX trading – like multiplier, “Take-Profit” and “Stop-Loss” orders – which are essential for your success. But before we dwell on this pro trader vocabulary, let’s begin at the beginning.
The cornerstone of your FOREX success
Apparently, it’s all about understanding currencies. One needs to know the quotes and which factors impact their dynamics. Otherwise you won’t be able to identify the moments of strongest volatility – meaning, the best money-making potential for a trader.
Understanding FOREX quotes
We have already mentioned the word “quote”, as it is one of the key terms in FOREX. It means a value of one currency expressed through the value of another.
There are plenty of currencies out there, but some of them have the biggest trading volumes in FX, so they are referred to as “majors”:
In fact, most of us see currency quotes every day, when we are walking past banks and exchange offices. 1.18 dollars per 1 euro is an example of a EUR/USD quote.
Speaking about dollars – they truly “rule” in the FX market. Most other currencies are valued against an American dollar, which is why all FOREX settlements are carried out in USD.
Types of FOREX quotes
Quotes on the FOREX market exist in 3 types: direct quotes, indirect quotes and cross currency pairs.
Direct quote is a pair which shows how much national currency is equivalent to 1 US dollar. So the quote which goes USD/CHF = 0.98000 means that you can buy 0.98 of a Swiss franc with 1 US dollar.
Indirect quote is the reverse: it shows how many US dollars are equivalent to 1 unit of the national currency. If AUD/USD = 0.77, it means that 1 Australian dollar can buy 0.77 American dollar.
Cross currencies are pairs without a dollar, like EUR/GBP or EUR/CHF. The settlements on cross-currencies are made using the respective quotes containing USD for all involved currencies, like this: EUR/JPY = EUR/USD * USD/JPY
Reading a FOREX quote
Now let’s try to read a currency quote.
GBP/USD = 1,33721
To the left of the slash is the base currency (GBP), to the right – the quote or the counter currency (USD). Remember: in FOREX, whenever you buy one currency, you simultaneously sell another. Base currency is a commodity, and the quote currency – the money with which the payment is made. In the example above you have to pay 1,33721 USD to buy 1 British pound. If you want to sell 1 pound, then 1,33721 USD is what you will receive.