Forex trading can be quite complex and confusing for beginners. However, there are some Basic Concepts of Forex Trading that everyone should know before getting started.
This article will explain some of the most important and Basic Concepts of Forex Trading, including PIPs, Forex Quotes, Margin, Leverage, and more. Later we list the answers and questions that most novice retail traders frequently ask when discussing the foreign exchange market or the “Forex Markets.”
By the end, you will have a better understanding of how forex trading works and what you need to do to get started.
The forex market is a process that enables opportunities for speculating on currency prices in the expectation of making profits. There are many currency pairs available to trade that move in both ways, upside or downside enabling traders to speculate either one currency will decline or gain against another.
However, before jumping into the forex market, learning the basic concepts of forex trading is mandatory, as most beginners lose money in the forex trading journey.
Basic Concepts of Forex Trading
What is a PIP?
The term “PIP” stands for Price Interest Point, meaning the smallest measurement unit of currency exchange. Most pairs go out to four decimal places to calculate pip values such as EUR/USD, GBP/USD, USD/CHF, etc., calculating pips at 0.0001, while exceptions like Japanese Yen pairs go out in two decimal places (0.01) to calculate pips.
A pip is usually equivalent to 1/100 of 1% or one basis point. For example, a trader says, “I make 30 pips profit,” meaning he gains profit by thirty pips price movement from a particular currency pair. The profit amount depends on the pip value or indirectly on the amount you invest.
What are Forex Quotes?
A Forex Quote is the price of one currency in terms of another currency. Currency pairs contain two currencies, a base currency and a quote currency, where the base currency is always equivalent to 1.
For example, the GBP/USD pair has a value of 1.2500, which means you can purchase one Great Britain Pound or British pound sterling for 1.2500 United States dollars. Many investors also call the quote currency or second currency the counter currency of a currency pair.
Forex Trading Currencies Risks
Forex trading involves greater risk due to margin trading, as the marketplace allows you to borrow money, but the responsibility of losing money is on the investor.
Many brokers allow retail traders to take significant leverage from 1:1 to 1:999, which means you can open positions worth $999 with your $1 capital. The riskiest part is if the forex market goes against the value of your investment amount, you lose your money.
So the odds against the reward are also significant. There are many risk factors in forex trading, including leverage risk, country risk, interest rate risk, political risk, counterparty risk, transaction risk, etc.
Key Forex Trading Terms
Before starting foreign exchange trading, any forex trader needs to familiarize themselves with the basic forex terminology. The most common or crucial forex trading terms are:
- Currency Pair: A currency pair involves two currencies, where you purchase one currency and sell another. These pairs of two currencies create quotes or exchange rates.
- Base and Quote Currency: The first currency or the currency pair is the base currency, and the second currency is the quote currency of that currency pair.
- Long Position: Being long refers to purchasing a trading forex asset with the expectation of rising value.
- Short Position: Opening short position refers to open sell positions on an investment asset in expectation of declining.
- Bid/Ask Price: The “Bid Price” is the forex market price to sell an asset, whereas the “Ask Price” is the market price for purchasing an asset. The difference between these two prices is the “Spread“, which fluctuates with the price change.
- Lot: Traders trade forex pairs in lots. A standard lot is equivalent to 100,000 units of the base currency. Meanwhile, a mini lot contains 10,000 units, and a micro lot includes 1,000 units.
- Margin: Maintaining an open position requires depositing a particular amount, which is the margin. For example, with a $5k deposit and 1:30 leverage, traders can open a position worth $150k.
- Stop Loss: Stop loss is a risk management tool that allows investors to close a position at a predefined price when the forex market reaches. It enables limiting losing positions in unfavorable market conditions.
- Take Profit: Take profit is a risk management tool that enables investors to close a position at a predefined price when the market reaches. Foreign exchange traders can exit from profitable forex trades by using this tool.
- Currency Swaps: A currency swap is a change taken by the broker to carry a trade overnight.
What are Foreign Exchange (Forex) Order Types?
The forex market involves various order types such as market orders, limit orders, stop orders, trailing stops, etc. Market execution orders refer to execution at the instant price, whereas pending or limited orders execute when the forex markets/ financial markets conditions meet the market participants’ desires.
For example, suppose the currency pair USD/GBP may be trading foreign exchange at 1.2550; if you place a buy (market execution) order, you get the price as it floats.
Meanwhile, you may place a buy limit order below the price near 1.2540, or a sell limit order above the price, maybe near 1.2560. If the price does not reach the limit order level, no order execution occurs.
Predicting Price Movements
Old or new forex traders use different techniques to predict the future price movement for any forex pair, including technical analysis and fundamental analysis alongside sentiments. Technical analysis refers to following various chart patterns, price actions, etc., depending on forex market data such as volume, primary price, past market data, price performance, technical indicators, etc.
Meanwhile, the fundamental analysis covers fundamental data of a currency pair, including interest rate decisions, major economic news releases, GDP, employment data, etc., and sentiment traders react to the headlines opening momentum-based positions.
Currency Markets Yield and Return
The yield curve usually plots the interest rate at a set period, a graph, or a line chart. The interest rate reflects bond interest rates, and financial analysts use the term “Yield Curve” when discussing any economy, particularly to forecast economic activity, inflation, and interest rate. There are positive, negative, and flat yield curves.
The return amount is the gaining or losing ratio against forex trading capital or initial investment.
How to Win with Carrying Trades
Carry trade forex is a currency trading strategy that allows collecting profits from interest rate differences between two different major currencies or others. The first step is to find a currency pair that offers a currency of high yield and the other with low yield.
For example, currency traders or foreign exchange traders apply this method in a global marketplace to trade forex major currency pairs with high-interest rate spreads like NZD/JPY, AUD/JPY, etc.
Liquidity and Volatility
Liquidity, in this case, refers to how quickly the asset you can turn into cash equivalent to the market value. Most assets are liquid at some point.
Meanwhile, volatility refers to the unpredictability of price change. When an asset price changes more than one percent of its value, you can consider it as a volatile asset.
Margin and Leverage
Margin is the amount traders need to open a position, and leverage refers to borrowing money from exchanges. Leverage is the term that allows multiplying exposure of a trader’s equity. Many online brokers offer 1:1- 1:999 leverage of traders’ capital.
You can consider leveraging a two-way sword that enables multiplying profit and can be a reason to blow novice forex traders or stock market accounts.
Choosing The Best Forex and CFD Broker
CFD stands for “Contract for Difference“, which enables speculating opportunities for financial investors through price fluctuations in many assets. Forex and CFD brokers provide investment services that comply with many countries’ operating regulations.
It is mandatory to check on the broker profile before depositing, as you must ensure your funds are in safe hands alongside confirming the best services. Best forex brokers provide 24-hour services to their clients, enabling investment opportunities in many assets alongside sharing research and educational content.
Trade with a Regulated Broker
It is essential to trade with a regulated broker. Regulators are agencies that have tasks to prevent fraudulent acts. Regulated brokers are registered through regulators and promise to provide services according to the regulator’s rules.
There are several regulation authorities, such as
- FCA – Financial Conduct Authority (United Kingdom)
- CySec – Cyprus Securities and Exchange Commission (Cyprus)
- CFTC – Commodities and Futures Trading Commission (United States)
- ASIC – Australian Securities and Investments Commission (Australia)
- CBUAE – Central Bank of the United Arab Emirates (United Arab Emirates)
- FINMA – Swiss Financial Market Supervisory Authority (Switzerland)
Forex Trading Strategy
A forex trading strategy usually refers to a forex trader’s technique to make profits from the market. Many forex trading strategies allow making constant profits through buying/selling currency pairs.
Thousands of forex trading strategies are available to participate in the forex market; you can choose one or more to make trade decisions.
Traders follow different forex trading strategies or trading styles, including scalping, swing trading, position trading, price action, etc.
Build Your Confidence
Building confidence before exchanging foreign currencies in the forex market is mandatory, as novice traders usually lose money on their first deposit. It will help if you choose a strategy or can create your own to participate in the market to help build your confidence.
Forex brokers enable opening demo accounts, so you can practice and prepare yourself to start forex trading.
Finally, this article introduces you to the forex market and the Basic Concept of Forex Trading. If you are new to the financial market, this article is not enough for you to start forex trading, and we suggest going through more research and practice sufficiently to gain the confidence to start live trading.
FAQ: Frequently Asked Questions
When Does The Forex Market Open?
The forex market is open 24 hours a day in different parts of the world, from Sunday 5 p.m. EST until Friday 4 p.m. EST. Any trader has access to the market 24 hours in different international time zones.
How Much Is The Forex Market Worth?
The forex market is the world’s largest marketplace and involves a $6.6 trillion daily volume.