What is Forex Trading?

What is Forex Trading?

Trading foreign exchange or currencies is also known as forex trading, with forex standing for Foreign Exchange. The central banks themselves participate in this market, but also international companies and investors who want to make a profit in these markets.

What are the characteristics of the forex markets?
The foreign exchange markets are the largest and most liquid markets on earth. They are open 24 hours a day during the week because currencies are traded in all time zones. Trading is possible between Sunday and Friday at 11 p.m. Central European time. In addition, the transaction costs are minimal and therefore the Forex markets represent one of the best realizations of the theoretical idea of ??a market economy. This means great opportunities, but also corresponding risks.

What is forex trading?
Investing in stocks allows you to participate in economic growth. In contrast, acquiring one currency for payment in another is a zero-sum game. The buyer’s gain is the seller’s loss and vice versa.
In forex tradingthere is an opportunity to trade with significant leverage. The investor can therefore acquire a sum in one currency and actually deposit only a fraction of it with his broker. This increases the possible profit, but also the extent of the possible loss. If the price changes in a way that is unfavorable for the investor, a so-called margin call is the result. The executing broker then demands an increase in the deposited capital. If the investor cannot meet this increase, the position is closed and the investor suffers a total loss.

How does forex trading work?
Unlike stocks, forex is primarily traded over-the-counter. As we will see, this type of trading also has a significant impact on investor strategies.

The crucial question for every investor is, of course, what factors influence prices in the forex markets. Only a superficial consideration makes it clear that there are very many such influences.
– central banks. Since all major currencies are now issued by central banks, the monetary policy of these central banks is of vital interest to forex traders. This includes setting the key interest rate and all other decisions that affect the inflation rate, for example. A key observation in this regard is that a currency with a higher interest rate is more likely to appreciate since every holder of that currency receives that higher interest rate. After a central bank has arbitrarily large amounts of its own currency available, it can also enforce a minimum exchange rate for its currency. It simply offers any buyer the currency for that rate and no one will then pay anywhere else. However, an upper limit for one’s own currency cannot be enforced in this way.
– In addition to central bank policy, the exchange rate of a currency is influenced by practically all economic data in the currency area. This includes stock prices, trade balances, commodity prices and much more. Other currency areas also play an indirect role, as they compete with the currency area in question.
– Last but not least, there are also irrational effects on currency rates. Trends and sensitivities are just as much a part of the starting material for every forex trader as statistics are.

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What are important terms and abbreviations in forex trading?
– PIP. These three letters stand for Points in Percentage. A pip is one-hundredth of a percent of currency rates other than the Japanese yen. One euro is worth roughly 100 yen and to keep the order of magnitude, in the case of the yen, one pip represents one percent. So if the exchange rate of one euro against dollars falls from 1.2004 to 1.2001, this corresponds to a loss of three pips.
– Long and short. A long position means that you have bought the relevant currency and are expecting the price to rise. With a short position, you owe the currency to a counterparty and hope that the price will fall.
– There is a difference between the price for buying and selling a currency, which is known as the spread between the bid and ask price. The larger the trading volume between two currencies, the smaller this spread.
– If a trade is executed immediately, you are on the spot market. With a future you buy a standardized and exchange-traded contract for the delivery of the currency at a later date. A forward also means delivery in the future, but is an over-the-counter agreement and can be concluded individually without standardization.

How to trade Forex profitably?
The short answer is that you should use all available information and deal as deeply as possible with the known market mechanisms. The trading success then makes a statement about how successfully you have achieved these goals. The key points include the following.
– Fundamental Analysis. This affects the policy of the central bank itself and the economic situation of the currency areas concerned.
– Technical analysis. This considers typical course developments and assumes that these will be repeated. A problem with this analysis of the forex markets is that due to the lack of centralized trading venues, much less information about turnover is available than in other markets.

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One way to partially deal with this problem is to use the CoT or Commitment of Traders reports, which appear weekly and show the positions of major market participants on the futures exchanges. For example, one simple way is to identify a clear trend in engagement in a certain direction. Then there are hardly any other major market participants available to further strengthen this trend, which can be used for your own positioning.
– Psychological analysis. This tries to assess the behavior of market participants, especially when it is not rationally comprehensible and, for example, there is extreme optimism or panic.

Practical points for forex trading
The first important decision is the choice of broker, which is the link between the investor and the interbank market. The scope and complexity of forex trading is evident from the fact that this choice is far more challenging than choosing an online broker to trade stock funds.

A key question is whether the broker has its own dealing desk. Such DD brokers offer courses for their own customers, so they only get these and no courses from the open market. Such brokers are not recommended because this type of price formation is not transparent and allows the broker to disadvantage their own customers with bad prices. A no-dealing-desk broker routes its clients’ orders to the interbank forex market and earns a fee in the process. But it is not that easy to recognize the DD brokers. This requires more in-depth investigations such as checking the broker’s financial record and relying on a regulator that is as reputable as possible. Another important criterion for choosing a broker is its turnover.

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It is not for nothing that Forex trading is considered one of the most fascinating fields of activity for traders. However, you should be aware that you are competing with professional traders there and that your own profit must first be taken from another market participant. Only those who are willing to put in the effort to study the subject carefully should venture into this area. With discipline, the right mental disposition and processing the latest information, you have a chance of being one of the winners in forex trading in the long term.

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