What is Forex Trading and how does it work?

Today we’re here to let you know what Forex Trading is and how you could get more out of this new trend in the world, which is also closely related to cryptocurrencies.

So you're probably missing out on something that will become more important in the coming years!

What is Forex Trading?

The term FOREX is a shorter way of saying Foreign Exchange and already with this info you’ll have a pretty clear idea of what it is, as it is a market where currencies are bought and sold from various parts of the world.

Now, to be more specific, we can say that FOREX is the largest financial market in the world, with an approximate movement of more than 5 trillion dollars.

Undoubtedly, it’s something you should pay attention to since it’s a union of all the stock exchanges around the world.

Currently, the Forex Market works 24 hours a day, 5 days a week in what is known as the interbank market.

It operates thanks to the global interbank network that is distributed in a total of 4 different and important financial centers located in different time zones of the world: London, New York, Sydney, and Tokyo.

How does Forex Trading work?

Before starting to trade Forex, the main thing is to understand how it works, since it’s a market.

It should be noted that it’s not the only one of its kind in this industry, so it’s important to know the most essential elements of how it operates through Forex Trading.

In this platform the main object of value that can be exchanged are currencies, so an equal exchange is negotiated between a pair of the many currencies that can be used, but giving attention to those used in a specific transaction either to buy and/or sell one currency or another.

At this point it’s necessary to understand what a currency pair is, so we’re going to name one of the most classic examples of this market, the Eurodollar, which can be identified as follows: EUR/USD.

In all currency pairs the currency on the left will always be taken as the main base currency, while the other becomes the secondary or quote currency.

In the case of the Eurodollar, the Euro would be sold considering a certain amount of dollars. But let's see it in an example: If it’s quoted at 1:20, for every 1 Euro you would have 1.20 dollars.

How do you use Forex Trading?

Imagine you are a Forex trader and you have heard news and rumors of a possible fall of the dollar compared to the euro.

Thanks to the EUR/USD you could issue an order to buy euros to support your capital, since by selling the dollars you would be buying the stronger currency and therefore selling the "weaker" one.

You will then issue a sell order again, but this time in the euro. If an increase in the value of the euro at par with the dollar is appreciated by means of the EUR/USD, this sell-and-buy order will generate a profit for the trader.

The same can happen if the opposite is the case since Forex trading allows users to back their capital in what they believe will be the stronger currency and, once they see fit, reinvest in the weaker currency so that, when it recovers its value, they have a greater amount of it.

Know the classification of currency pairs

As you’ve been able to see, Forex currencies are classified in different pairs, although it should be noted that they are also classified individually, as is the case of those of greater or lesser circulation, serving as an example the Turkish lira and the U.S. dollar.

Now that you understand this, you can realize that any currency can be exchanged for another, however, there are some of them that have a larger market and this may be for different reasons: importance, country of origin, weight in global trade, among other aspects.

However, we can classify them as follows:

1. Major pairs

This is where you can find the currencies that handle more than 80% of the world trade in the Forex market.

Here we can find currencies such as the US dollar (USD), the Euro (EUR), the British pound (GBP), the Japanese yen (JPY), the Swiss franc (CHF), the Canadian dollar (CAD), the Australian dollar (AUD) and finally the New Zealand dollar (NZD).

Having a high availability and liquidity in the market, the conditions offered by these currencies ensure a better edge in the different negotiations. An example of this is the low costs compared to other traded pairs. We give you some of them below:

EUR/USD: Euro - US Dollar (Eurodollar).
GBP/USD: British Pound - US Dollar.
USD/JPY: US Dollar - Japanese Yen.
USD/CHF: US Dollar - Swiss Franc.
USD/CAD: US Dollar - Canadian Dollar.
AUD/USD: Australian Dollar - US Dollar.
NZD/USD: New Zealand dollar - US dollar.

2. Minor pairs

In contrast to the major currency pairs, the minor currency pairs are less liquid and are not based on the US dollar. Because of this, they are forced to work with other major currencies that move the international market.

Here are some of the most common Forex minor currency seas: EUR/CHF, EUR/NZD, GBP/AUD, EUR/AUD, GBP/JPY, CAD/JPY, EUR/GBP.

3. Exotic pairs

From time to time, you may see an emerging currency in the market and this is when we’re talking about exotic currency pairs. These are characterized by low liquidity, as is their trading volume when compared to other countries.

Influencing factors in the quotation of currency pairs

There are certain aspects that influence the stock market, but this is not something new, it has been happening for many years. That’s why it’s important to know those factors that can cause the rise and/or fall of currencies. We will talk about the 3 main ones:

1. Political factors.

The government policy of each country has a direct influence on the rise and/or fall of the currency price, whether they make decisions to implement a new national project to boost the country's development or decide to close the border crossing, as was the case in many countries due to Covid and the outbreaks in recent years. Let us look at some specific examples:

Change in migration policies.
Changes in the country's legislation.
Territorial stability.
Measures on energy consumption.

2. Economic factors

Another factor that is subject to the decisions and/or political actions of a government is the economic factor, although multiple aspects can be analyzed.

GDP, national industrial production, data on oil reserves, inflation, debt, and/or unemployment are clear examples of how economic factors can affect the market. Broadly speaking, they are divided into two types of factors:

Macroeconomic

Gross Domestic Product or GDP.
Employability data.
National accounts.
Inflation.
National industrial production indexes.
Tourism indices.

Microeconomic

Changes in consumption habits.
Changes in production.
Changes in savings and investment decisions.

3. Psychological factors

Unlike the previous aspects, psychological factors do not have a classification but are a consequence of the previous ones.

The emotions provoked by certain news can lead to euphoria and/or hasty decisions, causing the value of a currency to rise or fall unexpectedly.

Forex currency situations

Now that you know the factors that can influence the behavior of different currencies, it’s important to take into account how they can behave together and/or in relation to each other.

For that, we want to give you a couple of examples:

Monetary policy of A is more intense than that of B: currency A will devalue, while B will appreciate, resulting in B strengthening against currency A.
Monetary policy of A is similar to that of B: there is no change in either one or the other, thus creating stability where neither devalues or appreciates against the other.
Monetary policy of A is less intense than that of B: currency B depreciates against currency A, causing B to devalue against A.

Advantages and disadvantages of Forex Trading

Forex is an increasingly popular tool among investors, it becomes obvious that it is because apart from what we have already told you, it offers some more additional advantages and as not everything can be good, it also has its disadvantages. Here we will tell you all about them:

Advantages

No centralization: since there is no central market, the costs for its use in each transaction are reduced.
Speed: all transactions are executed quickly, plus it has an incredible level of transparency, because Forex cannot be manipulated.
Availability: you can access all currencies that are available on Forex 24 hours a day, allowing you to obtain liquidity at any time.
Leverage and margin: options that will allow you to trade with more capital than is available in your account, giving you the possibility to earn more money with small investments.
Buying goods abroad: since it is available globally, all Forex users can use it to acquire properties, goods and/or services abroad and, if they wish, sell them later on.

Disadvantages

Unregulated market: since it isn’t regulated and there are conflicts between the parties involved in a transaction, it’s difficult for a specialized body to intervene to solve the problem.
Leverage: although it’s one of the most popular options in recent years, with a minimum capital it’s possible to gain a lot, but also to lose a lot. It's management that you must know how to perform.

IWhy use Forex?

All this that we’ve explained so far are the reasons why investors use Forex since it’s a platform that’s used to profit from currency pairs in order to profit from the weakening or strengthening of one currency against another.

This means that when you buy a weak currency you need less of your strong currency so that when the former recovers, you have a profit margin.

In this sense, there are different types of trading you can do in Forex, the most popular being scalping, intraday, swing trading, and position trading.

What can we conclude about Forex trading?

Basically, it’s a platform that can be used to make a profit in the short, medium, and long term, speculating with the market of currency pairs that are available on the platform.

However, all this that we’ve explained is only the beginning of what you can do with Forex, as it offers hundreds of uses.

In addition, you need to know the markets, something that can take a little more time. In other words, if you are interested in Forex Trading you need to prepare yourself and you still have time to do it here.

And if you have any doubt in your mind, leave it in the comments, maybe a member of our community can help you!

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