What is forex trading? How does it work? What are the benefits? Are there risks? What can you do to protect yourself?
This article will answer all these questions and more, so please stay with me and I will teach you everything you need to know about forex trading in the simplest way possible.
Forex is the abbreviation for “foreign exchange” and refers to the trading of currencies. Forex is the world’s largest and most liquid market for currencies. Nearly all currencies are traded against each other and also against a number of other financial instruments, such as shares and bonds.
It’s a market that trades currencies across borders. By far, the most popular currency traded is the US dollar. However, there are also other major currencies like the British pound, euro, Japanese yen, and Swiss franc.
Forex trading is not a highly technical field but if you are interested in it you should learn a few basic concepts. Here is a great beginners guide on Forex trading.
What is Forex trading?
Basically Forex trading is trading currencies. Forex offers a trading platform where you can buy and sell currencies for other currencies.
Here’s an example: You can exchange $10,000 US dollars for £10,000 pounds (for simplicity, assume that is the only currency traded). Or you can exchange £10,000 pounds for €10,000 euros.
As you can see, there is a huge variety of currencies and you can make trades against many currencies. The Euro was the largest currency traded on forex market in 2020. The second largest currency traded on forex market was the US dollar.
After the United States Dollar, the third biggest currency traded on forex market was the British Pound. So, if you want to trade currencies for real money, you must trade on foreign currency exchanges.
There are many things that can make Forex trading also very difficult to learn and trade, so to help you further I created this article on what makes Forex trading difficult which you can read by clicking here.
The risk associated with Forex trading
A Forex trading account will give you the opportunity to manage your money in multiple currencies. The risks associated with trading with Forex are rather high. All currency trading comes with a certain level of risk.
The higher the risk, the more you need to pay for it.
Let’s take a closer look at one of the risks involved with Forex trading:
High transaction fees Usually, Forex traders pay large transaction fees for any transactions made. This is because all the traders who are buying or selling currency are forced to use the same payment systems for doing so.
Each trader must pay the same amount in order to process their transaction. If you need to sell currency, you’ll have to pay a transaction fee to the currency broker.
How does Forex trading work?
The most important difference between Forex trading and regular stock trading is that currencies are not traded for their value but in exchange for other currencies or assets such as stocks. So the prices of currencies, depending on the time, their supply and demand will not be the same as those of shares.
This is why it is called “currency trading” and not “stock trading”. What is a Forex account? There are a few different types of Forex accounts. The simplest and most popular one is the Online Trading Account.
The advantage of this account is that you don’t have to visit a bank or open an account in person, nor do you need a bank account. You only need to deposit the funds and create your account. You don’t even have to provide any form of identification.
Trading currency pairs and currency pairs against another instrument means that your assets will consist of something that has value, such as gold, US dollars or silver, and some currency that has no value, such as euros.
Your assets will be traded between two opposing currencies in the form of shares, bonds or physical commodities such as gold and silver.
At the beginning of the trading day, a set of rules and procedures are set out by the respective forex institutions and their customers are given a few hours to place their orders. These order books are called the auction process, which is when one customer, known as a “bidder”, places an order to buy or sell.
The customer also places an order for the opposite side of the currency to take the opposite side of the sale or purchase.
To learn more to understand how to trade Forex successfully, then you will want to read the latest article I wrote clicking here.
The benefits of Forex trading
Forex trading can be an excellent way to make money.
Unlike buying and selling shares, Forex involves little or no capital outlay. The advantage of trading Forex is that you can buy and sell currency at the click of a button.
And the benefits of that in and of itself are enormous, especially if you are an individual or a small business looking to start or grow a business. You can profit from a fluctuating currency market and at the same time support your local currency.
In addition to the high profits that can be made from Forex trading, there are other benefits. One benefit of Forex trading is that it is anonymous. No financial records will be linked to your trading activities. Unlike buying and selling shares, no one will know what you bought or sold.
The biggest benefit to forex trading is the ability to earn money from virtually anywhere in the world. It is open 24 hours a day, 7 days a week, 365 days a year and can be accessed from anywhere in the world.
Most people can trade using their bank accounts in the UK, USA, Australia or Canada. The other great benefit of Forex trading is that you can make your money back with little risk. Some investors trade against other people’s money rather than your own.
What are the risks of Forex trading?
One of the biggest risks that you can run into when you trade in forex is running out of money. Some people have lost thousands of pounds over the years. If you have enough money to exchange between 1 and 1.5 million dollars, but not 1 million dollars, you are looking at running out of money if the market is not in your favour.
Even small variations in prices can have huge consequences. So how do you prevent yourself from running out of money?
Traders can achieve better margins by borrowing money to buy currencies at a lower rate. However, there are also risks with this. As you need to pay back the borrowed money in the very near future, there is always a danger that you will not be able to exchange your currency at the current market rate.
Forex trading is a high-risk undertaking. The size of the transactions are huge and there is no centralised data for them. Therefore, there is no central control. If there was some kind of system, things would be much easier, but they are not. This is why you should always be vigilant.
The main risks include:
- High and unpredictable volatility
- Spikes in the prices of currencies
- Unpredictable swings in the exchange rate between the currency pair that you are trading with
- Disruption of your broker’s system due to technical difficulties or DDoS attacks
- Black-market exchanges
These risks should not dissuade you from Forex trading, however, as they simply prove that you can lose money if you do not do your homework. There is no way to know in advance what currency will be used to make a successful trade.
What can you do to protect yourself?
First, forex trading is a high risk, high reward endeavour. Therefore, do not make a decision to invest your savings in forex trading without talking to a certified financial advisor or financial professional. A financial advisor can teach you how to make a profit and avoid a loss in forex trading.
Second, forex trading is a highly automated market and the market trends can change quite rapidly and at great speed, so keep your trading activities on a short leash.
Third, having a broker who can monitor and manage your trades and provide you with the necessary help is a great advantage.
Fourth, forex trading is a volatile market, so it is very important to keep trading costs to a minimum.
While your first venture into the world of forex trading can be confusing and difficult, you can continue learning the ropes in order to become a successful trader.
Just remember when you first start in Forex trading to protect yourself at all times from the risks associated with Forex. Yes it can be a very rewarding and profitable business endeavour, but like I just said there are high risks associated to trading any financial markets.
Finally… start on the correct path with getting the right Forex education, you can find many article and trading lessons on my blog. And if you are looking for more advanced education then you will want to check out my Forex trading courses clicking here.