What is forex trading and how does it work?

Online Forex Trading: A Beginner’s Guide

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Forex trading is the process of speculating on currency prices to potentially make a profit. Currencies are traded in pairs, so by exchanging one currency for another, a trader is speculating on whether one currency will rise or fall in value against the other.

The value of a currency pair is influenced by trade flows, economic, political and geopolitical events which affect the supply and demand of forex. This creates daily volatility that may offer a forex trader new opportunities.

Online trading platforms provided by global brokers like UIT mean you can buy and sell currencies from your phone, laptop, tablet or PC.


Understanding Currency Pairs

All transactions made on the forex market involve the simultaneous buying and selling of two currencies.

This ‘currency pair’ is made up of a base currency and a quote currency, whereby you sell one to purchase another. The price for a pair is how much of the quote currency it costs to buy one unit of the base currency. You can make a profit by correctly forecasting the price move of a currency pair.

UIT offers hundreds of combinations of currency pairs to trade including the majors which are the most popular traded pairs in the forex market. These include the Euro against the US Dollar, the US Dollar against the Japanese Yen and the British Pound against the US Dollar.

The table below looks at the most traded currency pair in the forex market.

Base Currency

The base currency is the first currency that appears in a forex pair and is always quoted on the left. This currency is bought or sold in exchange for the quote currency and is always worth 1.So, based on the example above, it will cost a trader 1.1918 USD to buy 1 EUR. Alternatively, a trader could sell 1 EUR for 1.1916 USD.When you are trading forex, you are always buying one currency and selling another at the same time.

Quote currencies

The second currency of a currency pair is called the quote currency and is always on the right. In EUR/USD for example, USD is the quote currency and shows how much of the quote currency you’ll exchange for 1 unit of the base currency.When you are trading forex, remember you are always trading a pair - so you are selling one to buy another.

Bid Price

The bid price is the value at which a trader is prepared to sell a currency. This price is usually to the left of the quote and often in red.The bid price is given in real time and is constantly updating as it is a live market.

Ask Price

The ask price is the value at which a trader accepts to buy a currency or is the lowest price a seller is willing to accept. This is usually to the right and in blue.The ask price is given in real time and is constantly changing as it is a live market.

Spread

As a forex trader, you’ll notice that the bid price is always higher than the ask price. The difference between these two prices is the spread. In other words, it is the cost of trading. The narrower the spread, the cheaper it costs. The wider the spread, the more expensive it is.For example, if EUR/USD is trading with an ask price of 1.1918 and a bid price of 1.1916, then the spread will be the ask price minus the bid price. In this case, 0.0002.In order to make a profit in foreign exchange trading, you’ll want the market price to rise above the bid price if you are long, or fall below the ask price if you are short.

Pips

A point in percentage – or pip for short – is a measure of the change in value of a currency pair in the forex market.It is the smallest possible move that a currency price can change which is the equivalent of a ‘point’ of movement.For most currency pairs, a pip is the fourth decimal place, the main exception being the Japanese Yen where a pip is the second decimal place.On the forex market, trades in currencies are often worth millions, so small bid-ask price differences (i.e. several pips) can soon add up to a significant profit. Of course, such large trading volumes mean a small spread can also equate to significant losses.Trading forex is risky, so always trade carefully and implement risk management tools and techniques.

What is a Forex Trader?

A currency trader, also known as a forex trader, will hold a ‘position’ in a currency pair. This is the term used to describe a trade in progress and one that will have a profit or a loss, as the open position indicates the trader has some market exposure.

To represent our positions below, we’ll be using EURUSD trading at 1.1916/1.1918 as an example.

A long position means a trader has bought a currency expecting its value to rise. Once the trader sells that currency back to the market (ideally for a higher price than he or she paid for it), their long position is said to be ‘closed’ and the trade is complete.

So if you wanted to open a long position on the Euro, you would purchase 1 Euro for USD 1.1918. You will then hold your position in the hope that it will appreciate, selling it back to the market at a profit once the price has increased.

A short position refers to a trader who sells a currency expecting its value to fall and plans to buy it back at a lower price. A short position is ‘closed’ once the trader buys back the asset (ideally for less than he or she sold it for).

In this case, if you think the Euro will weaken against the Dollar, you will sell 1 Euro for USD 1.1916 and hold a short position. You expect the Euro to depreciate and plan to buy it back at a lower rate.

What are the most traded currency pairs on the forex market?

There are seven major currency pairs traded in the forex market, all of which include the US Dollar in the pair.

You can also trade crosses, which do not involve the USD, and exotic currency pairs which are historically less commonly traded (and relatively illiquid). This means they often come with wider spreads, meaning they’re more expensive than crosses or majors.

Major currency pairs are generally thought to drive the forex market. They are the most commonly traded and account for over 80% of daily forex trade volume.

There are four traditional majors – EURUSD, GBPUSD, USDJPY and USDCHF – and three known as the commodity pairs – AUDUSD, USDCAD and NZDUSD.

These currency pairs typically have high liquidity, which means they tend to have lower spreads. They are associated with stable, well managed economies and are less prone to slippage, where the expected price of a trade differs from the price the trade was executed at.

Fundamental Analysis

This analysis is interested in the ‘why’ – why is a forex market reacting the way it does? Forex and currencies are affected by many reasons, including a country’s economic strength, political and social factors, and market sentiment. Basically, anything you can think of which gives you a clue to the market’s future direction.

> News & Economic Data

Investors and banks look for strong economies to place their funds, in the expectation that their capital will appreciate. This is because the currency of that country will be in demand as the outlook for the economy encourages more investment. Any news and economic reports which back this up will in turn see traders want to buy that country’s currency.

> Central Bank & Government Policy

Central banks determine monetary policy, which means they control things like money supply and interest rates. The tools and policy types used will ultimately affect the supply and demand of their currencies. A government’s use of fiscal policy through spending or taxes to grow or slow the economy may also affect exchange rates.

> Technical Analysis

Forex traders who use technical analysis study price action and trends on the price charts. These movements can help the trader to identify clues about levels of supply and demand.The aim of technical analysis is to interpret patterns seen in charts that will help you find the right time and price level to both enter and exit the market.

> Candlestick chart

This chart is a favourite amongst forex traders, as it shows similar information to a bar and line chart, but arguably in a better way.

The chart displays the high-to-low range with a vertical line and opening and closing prices. The difference to the bar charts is in the ‘body’ which covers the opening and closing prices, while the candle ‘wicks’ show the high and low.

If the candlestick is filled, then the currency pair closed lower than it opened. If the candlestick is hollow, then the closing price is higher than the opening price.

> Bar chart

A bar chart shows the opening and closing prices, as well as the high and low for that period.

The top of the bar shows the highest price paid, and the bottom indicates the lowest traded price.

The whole bar represents the currency pair's whole trading range and the horizontal marks on the sides indicate the opening (left) and the closing prices (right).

A bar chart is most commonly used to identify the contraction and expansion of price ranges.

> Line chart

A line chart is easy to understand for trading beginners. It simply shows a line drawn from one closing price to the next.

When connected, it is simple to identify a price movement of a currency pair through a specific time period and determine currency patterns.

How to start trading with a forex broker?

UIT gives you access to trading forex as you can execute your buy and sell orders on their trading platforms.

You should always choose a licensed, regulated broker that has at least five years of proven experience. These brokers will offer you peace of mind as they will always prioritise the protection of your funds.

Once you open an active account, you can start trading forex — and you will be required to make a deposit to cover the costs of your trades. This is called a margin account which uses financial derivatives like CFDs to buy and sell currencies.

It is important to remember that trading for beginners isn’t an overnight process. It takes time to become familiar with the markets and there’s a whole new vocabulary to learn.

For this reason, UIT offer a wealth of resources to learn to trade forex.

Once you’re ready to move on to live trading, we’ve also got a great range of trading accounts and online trading platforms to suit you.

Learn forex trading

UIT firmly believes that developing a sound understanding of the markets is your best chance at success as a forex trader. That’s why we offer a vast range of industry-leading educational resources in a variety of languages which are tailored to the needs of both new and more experienced traders.

These include Ebooks, daily market analysis, a variety of videos, and more long read guides just like this one!

There are also many forex tools availabl to traders such as margin calculators, pip calculators, profit calculators, foreign exchange currency converters, economic data calendars and trading signals.

Forex widgets can help to enhance your trading experience. Some of the most popular widgets include Live Rates Feed, Live Commodities Quotes, Live Indices Quotes, and Market Update widgets.

All of this information and resource is designed to help build your confidence to become a more profitable and long-term forex trader.