• The foreign exchange (also known as forex or FX) market is a global marketplace for exchanging national currencies.
• Because of the worldwide reach of trade, commerce, and finance, forex markets tend to be the largest and most liquid asset markets in the world.
• Currencies trade against each other as exchange rate pairs. For example, EUR/USD is a currency pair for trading the euro against the U.S. dollar.
• Forex markets exist as spot (cash) markets as well as derivatives markets, offering forwards, futures, options, and currency swaps.
• Market participants use forex to hedge against international currency and interest rate risk, to speculate on geopolitical events, and to diversify portfolios, among other reasons.

What Is the Forex Market?

The foreign exchange market is where currencies are traded. Currencies are important because they allow us to purchase goods and services locally and across borders. International currencies need to be exchanged to conduct foreign trade and business.

If you are living in the United States and want to buy cheese from France, then either you or the company from which you buy the cheese has to pay the French for the cheese in euros (EUR). This means that the U.S. importer would have to exchange the equivalent value of U.S. dollars (USD) for euros.

The same goes for traveling. A French tourist in Egypt can’t pay in euros to see the pyramids because it’s not the locally accepted currency. The tourist has to exchange the euros for the local currency, in this case the Egyptian pound, at the current exchange rate.

One unique aspect of this international market is that there is no central marketplace for foreign exchange. Rather, currency trading is conducted electronically over the counter (OTC), which means that all transactions occur via computer networks among traders around the world, rather than on one centralized exchange. The market is open 24 hours a day, five and a half days a week, and currencies are traded worldwide in the major financial centers of Frankfurt, Hong Kong, London, New York, Paris, Singapore, Sydney, Tokyo, and Zurich—across almost every time zone. This means that when the U.S. trading day ends, the forex market begins anew in Tokyo and Hong Kong. As such, the forex market can be extremely active anytime, with price quotes changing constantly.

A Brief History of Forex

In its most basic sense, the forex market has been around for centuries. People have always exchanged or bartered goods and currencies to purchase goods and services. However, the forex market, as we understand it today, is a relatively modern invention.

After the Bretton Woods accord began to collapse in 1971, more currencies were allowed to float freely against one another. The values of individual currencies vary based on demand and circulation and are monitored by foreign exchange trading services.2

Commercial and investment banks conduct most of the trading in forex markets on behalf of their clients, but there are also speculative opportunities for trading one currency against another for professional and individual investors.

There are two distinct features of currencies as an asset class:

• You can earn the interest rate differential between two currencies.
• You can profit from changes in the exchange rate.

An investor can profit from the difference between two interest rates in two different economies by buying the currency with the higher interest rate and shorting the currency with the lower interest rate. Prior to the 2008 financial crisis, it was very common to short the Japanese yen (JPY) and buy British pounds (GBP) because the interest rate differential was very large. This strategy is sometimes referred to as a carry trade.

How to Start Trading Forex

Trading forex is similar to equity trading. Here are some steps to get yourself started on the forex trading journey.

1.    Learn about forex: While it is not complicated, forex trading is a project of its own and requires specialized knowledge. For example, the leverage ratio for forex trades is higher than for equities, and the drivers for currency price movement are different from those for equity markets. There are several online courses available for beginners that teach the ins and outs of forex trading.

2.    Set up a brokerage account: You will need a forex trading account at a brokerage to get started with forex trading. Forex brokers do not charge commissions. Instead, they make money through spreads (also known as pips) between the buying and selling prices.

For beginner traders, it is a good idea to set up a micro forex trading account with low capital requirements. Such accounts have variable trading limits and allow brokers to limit their trades to amounts as low as 1,000 units of a currency. For context, a standard account lot is equal to 100,000 currency units. A micro forex account will help you become more comfortable with forex trading and determine your trading style.

3.    Develop a trading strategy:While it is not always possible to predict and time market movement, having a trading strategy will help you set broad guidelines and a road map for trading. A good trading strategy is based on the reality of your situation and finances. It takes into account the amount of cash that you are willing to put up for trading and, correspondingly, the amount of risk that you can tolerate without getting burned out of your position. Remember, forex trading is mostly a high-leverage environment. But it also offers more rewards to those who are willing to take the risk.  

4.    Always be on top of your numbers: Once you begin trading, always check your positions at the end of the day. Most trading software already provides a daily accounting of trades. Make sure that you do not have any pending positions to be filled out and that you have sufficient cash in your account to make future trades.

5.    Cultivate emotional equilibrium: Beginner forex trading is fraught with emotional roller coasters and unanswered questions. Should you have held onto your position a bit longer for more profits? How did you miss that report about low gross domestic product (GDP) numbers that led to a decline in overall value of your portfolio? Obsessing over such unanswered questions can lead you down a path of confusion. That is why it is important to not get carried away by your trading positions and cultivate emotional equilibrium across profits and losses. Be disciplined about closing out your positions when necessary.    

Forex Terminology

The best way to get started on the forex journey is to learn its language. Here are a few terms to get you started:

• Forex account: A forex account is used to make currency trades. Depending on the lot size, there can be three types of forex accounts:

1. Micro forex accounts: Accounts that allow you to trade up to $1,000 worth of currencies in one lot.
2. Mini forex accounts: Accounts that allow you to trade up to $10,000 worth of currencies in one lot.
3. Standard forex accounts: Accounts that allow you to trade up to $100,000 worth of currencies in one lot. 

• Ask: An ask (or offer) is the lowest price at which you are willing to buy a currency. For example, if you place an ask price of $1.3891 for GBP, then the figure mentioned is the lowest that you are willing to pay for a pound in USD. The ask price is generally greater than the bid price.
• Bid: A bid is the price at which you are willing to sell a currency. A market maker in a given currency is responsible for continuously putting out bids in response to buyer queries. While they are generally lower than ask prices, in instances when demand is great, bid prices can be higher than ask prices.
• Bear market: A bear market is one in which prices decline among currencies. Bear markets signify a market downtrend and are the result of depressing economic fundamentals or catastrophic events, such as a financial crisis or a natural disaster.
• Bull market: A bull market is one in which prices increase for all currencies. Bull markets signify a market uptrend and are the result of optimistic news about the global economy.
• Contract for difference: A contract for difference (CFD) is a derivative that enables traders to speculate on price movements for currencies without actually owning the underlying asset. A trader betting that the price of a currency pair will increase will buy CFDs for that pair, while those who believe its price will decline will sell CFDs relating to that currency pair. The use of leverage in forex trading means that a CFD trade gone awry can lead to heavy losses.
• Leverage: Leverage is the use of borrowed capital to multiply returns. The forex market is characterized by high leverages, and traders often use these leverages to boost their positions.
• Example: A trader might put up just $1,000 of their own capital and borrow $9,000 from their broker to bet against the EUR in a trade against the JPY. Since they have used very little of their own capital, the trader stands to make significant profits if the trade goes in the correct direction. The flipside to a high-leverage environment is that downside risks are enhanced and can result in significant losses. In the example above, the trader’s losses will multiply if the trade goes in the opposite direction.  
• Lot size: Currencies are traded in standard sizes known as lots. There are four common lot sizes: standard, mini, micro, and nano. Standard lot sizes consist of 100,000 units of the currency. Mini lot sizes consist of 10,000 units, and micro lot sizes consist of 1,000 units of the currency. Some brokers also offer nano lot sizes of currencies, worth 100 units of the currency, to traders. The choice of a lot size has a significant effect on the overall trade’s profits or losses. The bigger the lot size, the higher the profits (or losses), and vice versa.
• Margin: Margin is the money set aside in an account for a currency trade. Margin money helps assure the broker that the trader will remain solvent and be able to meet monetary obligations, even if the trade does not go their way. The amount of margin depends on the trader and customer balance over a period of time. Margin is used in tandem with leverage (defined above) for trades in forex markets.
• Pip: A pip is a “percentage in point” or “price interest point.” It is the minimum price move, equal to four decimal points, made in currency markets. One pip is equal to 0.0001. One hundred pips are equal to 1 cent, and 10,000 pips are equal to $1. The pip value can change depending on the standard lot size offered by a broker. In a standard lot of $100,000, each pip will have a value of $10. Because currency markets use significant leverage for trades, small price moves—defined in pips—can have an outsized effect on the trade.
• Spread: A spread is the difference between the bid (sell) price and ask (buy) price for a currency. Forex traders do not charge commissions; they make money through spreads. The size of the spread is influenced by many factors. Some of them are the size of your trade, demand for the currency, and its volatility.
• Sniping and hunting: Sniping and hunting is the purchase and sale of currencies near predetermined points to maximize profits. Brokers indulge in this practice, and the only way to catch them is to network with fellow traders and observe for patterns of such activity.

Basic Forex Trading Strategies

The most basic forms of forex trades are a long trade and a short trade. In a long trade, the trader is betting that the currency price will increase in the future and they can profit from it. A short trade consists of a bet that the currency pair’s price will decrease in the future. Traders can also use trading strategies based on technical analysis, such as breakout and moving average, to fine-tune their approach to trading.

Depending on the duration and numbers for trading, trading strategies can be categorized into four further types:

• A scalp trade consists of positions held for seconds or minutes at most, and the profit amounts are restricted in terms of the number of pips. Such trades are supposed to be cumulative, meaning that small profits made in each individual trade add up to a tidy amount at the end of a day or time period. They rely on the predictability of price swings and cannot handle much volatility. Therefore, traders tend to restrict such trades to the most liquid pairs and at the busiest times of trading during the day.
• Day trades are short-term trades in which positions are held and liquidated in the same day. The duration of a day trade can be hours or minutes. Day traders require technical analysis skills and knowledge of important technical indicators to maximize their profit gains. Just like scalp trades, day trades rely on incremental gains throughout the day for trading.
• In a swing trade, the trader holds the position for a period longer than a day; i.e., they may hold the position for days or weeks. Swing trades can be useful during major announcements by governments or times of economic tumult. Since they have a longer time horizon, swing trades do not require constant monitoring of the markets throughout the day. In addition to technical analysis, swing traders should be able to gauge economic and political developments and their impact on currency movement.
• In a position trade, the trader holds the currency for a long period of time, lasting for as long as months or even years. This type of trade requires more fundamental analysis skills because it provides a reasoned basis for the trade.

Line Charts

Line charts are used to identify big-picture trends for a currency. They are the most basic and common type of chart used by forex traders. They display the closing trading price for the currency for the time periods specified by the user. The trend lines identified in a line chart can be used to devise trading strategies. For example, you can use the information contained in a trend line to identify breakouts or a change in trend for rising or declining prices.

While it can be useful, a line chart is generally used as a starting point for further trading analysis.

Bar Charts

Much like other instances in which they are used, bar charts are used to represent specific time periods for trading. They provide more price information than line charts. Each bar chart represents one day of trading and contains the opening price, highest price, lowest price, and closing price (OHLC) for a trade. A dash on the left is the day’s opening price, and a similar dash on the right represents the closing price. Colors are sometimes used to indicate price movement, with green or white used for periods of rising prices and red or black for a period during which prices declined.

Bar charts for currency trading help traders identify whether it is a buyer’s market or a seller’s market.

Candlestick Charts

Candlestick charts were first used by Japanese rice traders in the 18th century. They are visually more appealing and easier to read than the chart types described above. The upper portion of a candle is used for the opening price and highest price point used by a currency, and the lower portion of a candle is used to indicate the closing price and lowest price point. A down candle represents a period of declining prices and is shaded red or black, while an up candle is a period of increasing prices and is shaded green or white.

The formations and shapes in candlestick charts are used to identify market direction and movement. Some of the more common formations for candlestick charts are hanging man and shooting star.

Content Courtesy: Investopedia