What Do You Trade On The Foreign Exchange?
One of the most common questions about Forex trading is…what EXACTLY do you trade on the foreign exchange market?
If you are keen on getting an answer to this question, you are in the right place.
Below is an depth discussion to help you understand exactly what is traded by Forex traders.
There is this common misconception about Forex exchanging and trading. Most people think it is one and the same thing. This isn’t the case.
Forex ‘exchanging’ is simply exchanging one currency for another according to current currency exchange rates. Forex trading on the other hand refers to the buying and selling of currency pairs. Forex traders trade currency pairs.
The 4 Major Currency Pairs
As the name suggests, currency pairs are just that. There are very many currency pairs Forex traders can choose to buy or sell. There are however four main currency pairs (based on their popularity).
Although it is possible to trade any pair you want, it is advisable to learn how to trade the 4 major currency pairs because they are the most liquid. This has many advantages (i.e. you can buy and sell major currency pairs anytime).
Also, it is cheaper to buy and sell major pairs because they feature low spreads (the difference between the bid and ask price).
Before looking at the 4 major currency pairs, it is important to understand what it means to pair up and trade currencies.
When you buy a currency pair like EUR/USD, it simply means you have bought the currency on the top (numerator) and sold the currency on the bottom (denominator). In our example, buying the currency pair (EUR/USD) means you have bought the Euro and sold the Dollar at the same time.
A Forex trader would be justified to buy the EUR/USD pair if he or she believes the Euro will strengthen over the dollar. They may choose to sell the currency pair when they believe the opposite will happen i.e. dollar will strengthen over the Euro.
The 4 major currency pairs are; EUR/USD, USD/JPY, GBP/USD and USD/CHF. The USD, EURO, JPY and CHF stand for United States Dollar, Euro, Japanese Yen and Swiss Franc respectively.
As mentioned above, Forex traders trade the major pairs and all the other pairs based on the currencies they expect to strengthen or weaken. It is important to note that you can make money both ways in Forex trading (i.e. when a currency pair is rising or falling).
The most important thing is analyzing individual currency pairs to make accurate assessments.
You can use fundamental or technical analysis to establish the direction of currency pairs.
Fundamental analysis involves using financial/economic news to determine whether a certain currency will rise or fall. Technical analysis involves studying currency pair charts and graphs using indicator to determine price direction.
Although there are traders who use one type of analysis to make buying and selling decisions, it is important to use both for more accuracy.
Currency pair prices are influenced by things like interest rate announcements, GDP data, unemployment rates, political instability e.t.c. It is therefore important to stay alert as a Forex trader to avoid missing important economic and financial announcements that give important price direction clues.
Ways To Trade Forex
Although there are many ways to trade, these are some of the most common.
An FX spot or Forex exchange spot transaction is an agreement between 2 parties to buy or sell one currency against the other at a price and date that is agreed upon.
The date of settlement is usually known as the spot date. The spot exchange rate refers to the exchange rate used for the transaction.
As of 2010, FX spot transactions worldwide reached the $1.5 trillion mark accounting approximately 37% of all foreign exchange transactions.
You can also trade Forex futures if you want to participate in the Forex market and you are interested in futures.
Traditional futures and Forex futures work on the same basic principle i.e. they are contracts to sell or buy a certain amount of an asset at a certain price on a predetermined date.
The main difference between Forex futures and traditional futures lies in centralized exchanges. Forex futures aren’t traded on centralized exchanges like traditional futures.
The Forex exchange market also offers Forex traders an opportunity to trade options. Forex options give Forex traders an opportunity to limit trading risks as well as increase profit.
Because options trading is OTC (Over The Counter), Forex traders choose the date and price on which an option is to be deemed valid and then receive quotes stating the premium they have to pay for the option.
The rest is the same as trading traditional options.
ETFs (Exchange Traded Funds)
Currency ETFs copy the movement of currencies in the Forex market by using futures contracts or holding cash deposits in currencies being tracked.
Whichever method a trader uses, traders should give highly correlated returns to actual movements of currency over time.
Currency ETFs are also perfect for anyone who wants to trade Forex indirectly. You can buy ETFs tracking individual currencies.
For instance, the Swiss Franc (CHF) is tracked by the NYSE: FXF (CurrencyShares Swiss Franc Trust).
You can choose to buy this ETF if you think the Swiss Franc will rise against the United States dollar.
You can sell the ETF if you think the opposite will happen. It is also possible to buy ETFs tracking more than one currency i.e. NYSE:UUP and NYSE:UDN.
It all depends on your preferences.
The Mechanics Of A Forex Trade
The mechanics of a Forex trade touch on 4 main things namely; placing an order, order types, exiting a position and calculating profit/loss.
As mentioned above, you have to use fundamental and technical analysis to determine the direction of a currency pair. After doing this, you have to understand the bid and ask price as well as spread to be able to place an order.
The spread is the difference between the bid and ask price. It is simply the amount you have to pay your broker as commission to buy or sell a currency pair.
There are 3 main types of orders in Forex trading namely; market, limit and stop order.
As the name suggests, the market order is a real-time order that allows you to buy or sell a currency pair instantly at the market price.
A limit order gives Forex broker instructions to execute a trade at a specific price.
A stop order gives instructions to a Forex broker to exit a trade. This order is usually executed when the market goes against a trader’s expectations.
Stop orders allow traders to limit their losses on bad trades. A typical stop order is characterized by a stop loss which cuts losses at a specific price when the market goes against the expectations of a trader.
Profits or losses in Forex trading are calculated according to the number of pips made or lost per trade. A pip is the smallest change in the price of a currency pair.
The number of pips per trade determines the amount of profit or loss a trader makes.
What Are The Forex Trading Hours?
Lucky for us, the Forex market is open 24 hours a day 5 days a week!
It is therefore possible to trade continuously from Monday to Friday (day and night) provided you have access to a computer and internet connection.
Unlike retail Forex traders, institutional traders are limited by trading hours because they have to trade in their respective workplaces within working hours.
Below is a breakdown of trading hours/sessions per region in GMT.
Open 8AM, Close 5PM (LONDON)
Open 7AM, Close 4PM (Frankfurt)
Open 1PM, Close 10PM (New York)
Open 2PM, Close 11PM (Chicago)
Open Midnight, Close 9AM (Tokyo)
Open 1AM, Close 10AM (Hong Kong)
Open 10PM, Close 7AM (Sydney)
Open 10PM, Close 6AM (Wellington)
No matter where you are in the world, there is a trading time to fit your needs.
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