Forex Basics

The foreign exchange market as we know it today originated in 1973. Before that, it was mere exchange of major currencies with relatively stable fluctuations and little speculations. Between 1971 and 1993 and through several international agreements and accords, attempts were made to establish economic stability around the world, separate Europe dependency on the US dollar, pegging currencies to other than the US dollar, and eventually obtain limited fluctuations, and they all failed, leading us to the free-floating system of the forex market as we know it today.

The major currencies today move independently from other currencies. The currencies are traded by anyone who wishes. This has caused a recent influx of speculation by banks, hedge funds, brokerage houses and individuals. Central banks intervene on occasion to move or attempt to move currencies to their desired levels. The underlying factor that drives today’s forex markets, however, is supply and demand. The free-floating system is ideal for today’s forex markets.

Basics of the Forex Market

The Foreign Exchange market, also referred to as the “Forex” or “FX” market is the largest financial market in the world, with an average traded value that exceeds $1.9 trillion per day and includes all of the currencies in the world.

“Foreign Exchange” is the simultaneous buying of one currency and selling of another. Currencies are traded in pairs, for example Great British Pound/US Dollar (GBP/USD) or US Dollar/Swiss Franc (USD/CHF).

There are two reasons to buy and sell currencies: about 5% of daily turnover is from companies and governments that buy or sell products and services in a foreign country or must convert profits made in foreign currencies into their domestic currency; the other 95% is trading for profit, or speculation.

For speculators, the best trading opportunities are with the most commonly traded (and therefore most liquid) currencies, called “the Majors.” Today, more than 85% of all daily transactions involve trading of the Majors, which include the US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar.

A true 24-hour market, Forex trading begins each day in Sydney, and moves around the globe as the business day begins in each financial center, first to Tokyo, London, and New York. Unlike any other financial market, investors can respond to currency fluctuations caused by economic, social and political events at the time they occur – day or night.

The FX market is considered an Over-The-Counter (OTC) or ‘interbank’ market, due to the fact that there is no central marketplace for currency exchange, and transactions are conducted between two counterparts over the telephone or via an electronic network.

Entering the Market

The first step for becoming an FX trader is to open an account with a forex Broker. Brokers in these markets usually give the investors the opportunity to test their trading system and trading facilities through opening a demo account on their trading platform and start practicing buying and selling currencies.

The most important aspect of FX trading is to understand the FX platforms, as they are the direct connection to the financial and forex markets. They are the software you use to place your orders, watch the market prices and also place transactions.

As a trader, you would be sitting at the computer screen, looking for signals and interpreting whether to buy or sell. The main concept is to buy a product hoping to sell it on a higher price or vice versa, so that the difference is your profits, i.e. you need to buy low and sell high.

Tools to get Started

» Computer; » Reliable internet connection; » Forex Broker; » Trading software (trading platform) – usually made available by the broker; » Trading capital.

Choosing your Forex Broker

With a click of the mouse, from just about anywhere in the world, you can buy and sell stocks using an online broker. The right tools for the trade are key to every successful venture; finding success in the market begins with choosing the right broker.

When choosing the most suitable broker that would balance your needs as an investor and as a client, you must consider the key items below:

  • Due Diligence: do your own research to find a broker that suits your individual needs and meets your requirements, such as whether the broker is regulated, in what domain it operates, its capitalization, etc… The broker’s background also matters.
  • Commissions/Spreads: Most forex brokers do not charge explicit commissions on their trades. They are into the bid/ask spread. Check their pip spreads each offers on trades.
  • Dealing Desk/Non-Dealing Desk: Some Dealers collect prices from a number of outside sources (ECN) and pass them through directly to their customers. Others make prices themselves based on outside sources.
  • Types of Accounts: Brokers can offer a variety of accounts:
    1. Demo where no funds at risk, and meant for practicing and testing;
    2. Micro (tiny leverage) accounts that might be suitable for those just getting started in forex trading;
    3. Mini (small leverage) accounts that might be suitable for those with limited currency trading experience;
    4. Full (normal leverage) accounts are most suitable for experienced foreign exchange traders.

Check with your broker for capital requirements for each type of account.

  • Platforms: check the trading program you will be using as some are web-based and some are downloaded directly to your desktop. As you can’t always be at a computer, check to see what other options the firm offers for placing trades, open demo accounts to see which platform works best for you.
  • Additional Features: Different platforms provide different features. Almost all provide charting of some kind. Some can include some very sophisticated trading analysis software, analysis tools, etc….
  • Customer Service: check what options and services the broker offers to its clients. Call the company’s help desk with a fake question to test how long it takes to get a response.