When I was first introduced to foreign exchange trading by my friend a few years back I found it very fascinating but did not quite well understand it until sometime later on. The idea of just buying a given currency and then selling it later on at a margin sounded so simple and I was excited about making quick cash from my new learnt venture. Just like me, you might as well be interested to start trading currency and probably turn it into your passive income earner which might surpass your monthly income from your daily job over time.
However, before you delve into this massive market and start minting your own money, I will share with you a few pieces of information about the currency market and currency trading in general. Just like my friend told me back then when he was introducing me into forex trading, I will emphasize the fact that information is power when trading on currency markets. Understanding how big the market is and how trading takes place in the market will help you avoid huge trading mistakes that might wipe off all your investment in a second. As it is with every other market, the more information you have about the underlying assets and the better you are equipped with trading skills and techniques; the more likely you are to gain higher market beating margins.
What is a forex market?
Currency trading takes place in what is referred to as a forex (FX) market; being a short form of foreign exchange market. The forex market is the largest market in the world and it also enjoys the highest liquidity with over $5 trillion in average trading value per day. In the currency market, participants buy and sell currencies based on their speculation about the exchange rate movement of two pairs of currencies of their choice. Unlike the stock markets that are centrally controlled and regulated, the forex market is not centrally governed by any government or institution. Individual traders from across the world interact and trade with each other through an interconnection of computers globally on a 24 hours per day basis.
Who are the participants in the forex markets?
Traditional forex markets participants have been commercial companies when facilitating their international trade, central banks, other commercial banks, hedge funds, investment management firms, investors and retail forex brokers. The latter facilitates currency exchanges for small businesses involved in cross-border trade as well as for individuals travelling to other countries who need to get the local currency of the country they are visiting. Central banks which one of the largest players in the market engage in forex trading not for profit making motives, but mainly for economic policy factors.
Due to the increase in international trade between countries across the world, a lot of currency exchange takes place every day in order to settle payments in the local currency for the receiving country or in dollars for dollar dominated business deals. Central banks also set their own minimum limits they need to have for foreign currencies to facilitate government expenditure on imports. This demand for different currencies across the world at any given time shifts the demand and supply of the currencies relative to others and thereby changing its value. It is this fluctuation in the value of one currency relative to another that speculators in the forex market capitalize on to make gains if the forex rates move in their favor. You can choose to trade in person or through forex broker who executes your trades based on your instructions and earns a commission when you buy and sell your currencies.
How is currency trading done?
A typical currency trade involves no physical exchange of currencies, but rather it involves computer entries which are then netted based on the market prices. Trading always is in pairs; with a trader going long on one currency and short on the other for each trade they undertake. For instance, in trade where you are exchanging US dollars for Japanese yen, you will be going short on the US dollars since you are giving them away and going long on the Japanese yen since you shall be receiving them in exchange. The same principle that applies when you buy a loaf in a shop applies in the forex market. When you give away money to get the loaf you are going short of the money but going long on the loaf. The only difference is that in currency trading, no physical exchange happens; only computer entries record the transactions and your respective forex accounts are updated accordingly.
Just like in the normal market, buying low and selling high is the guiding rule of thumb in the forex market too. The aim is study the trends in prices for the currency pairs that you are trading in and know the right time to buy and the right time to sell. In addition, being aware of the environmental factors that drive the trends such as economic data releases from the governments and geopolitics will help you in making informed speculations that will help to be successful in currency trading.