Forex Trading: Risky business or wealth generating?

Foreign Exchange Market or Forex, in short, the currency market, offers traders great profit opportunities. However, trading requires profound knowledge and experience, as trading the foreign exchange market involves a high level of risk.

Currency trading has a long history, and the Foreign exchange market was already traded in ancient Greece: At that time, Middle Eastern traders exchanged currencies to buy goods from European partners and vice versa. This still relatively simple currency exchange was usually carried out based on the weight and material of the respective currency. Large trading families such as the Medici in Italy or entire trading nations such as Great Britain shaped the foreign exchange market in the 16th century.

An institutional form of foreign exchange trading developed towards the end of the 19th century. At that time, it was possible for the first time to have your own private account abroad and have amounts credited there in the respective national currency. With the introduction of the International Monetary Fund, the World Bank and the Bretton Woods Agreement, fixed exchange rates between the currencies were established during the Second World War.

After the central banks had initially agreed to intervene in the event of sharp price fluctuations, this restriction was gradually lifted so that exchange rates can now rise and fall freely. However, major state crises have shown that the central banks or states themselves intervene to compensate for sharp price declines.

What is Forex?

Forex is an abbreviation for the English term “Foreign Exchange Market” The terms currency market and FX market are also used synonymously. Forex is the largest financial market in the world. More than 5 trillion US dollars in sales are generated every day.

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On the foreign exchange market, traders can buy and sell currencies. The principle is similar to currency exchange on vacation. If, for example, a holidaymaker travels from Germany to the USA and transfers 100 Euros into dollars before departure, the amount of dollars received is calculated based on the exchange rate. When the holidaymaker returns to Germany, he can exchange his dollars for Euros again. If the exchange rate is higher, he benefits from the exchange but, if the exchange rate is lower, the transfer will cost him money.

Anyone can Trade

Forex is neither bound to a fixed place nor to fixed times. Except on weekends, traders can buy or sell currencies almost 24 hours a day. This distinguishes Forex trading from equity trading, which is linked to the respective stock exchanges and the opening hours of the stock markets.

In principle, anyone can trade foreign exchange from anywhere in the world, provided they have an Internet connection. However, trading foreign exchange is associated with very high risks. The FX market is, therefore, less suitable for beginners with no experience.

In Forex, for example, traders must bear in mind that a weak dollar results in it being weaker against all currencies. If a trader has now bought foreign exchange in different currencies, he must expect losses everywhere if he only trades the dollar against other currencies.

The Trading Hours

Forex takes into account four main trading hours. The opening hours of the stock exchanges in New York, London, Tokyo and Sydney are taken into count. The markets are closed on weekends. Due to the time difference and the opening hours of each country, traders can trade foreign exchange almost 24 hours a day during the week.

Particularly worthwhile trading hours are weekly on working days between 13.00 and 17.00 o’clock GMT. During this period, the markets in the USA and Europe are open at the same time.

The four main trading hours

Sydney time: GMT +10

Tokyo time: GMT +9

New York time: GMT -4

London time: GMT +1

Forex Currencies

The exchange rate is the amount of currency needed to buy another currency. A synonym for exchange rate is FX rate. Forex usually uses two different forms of exchange rates. The “spot rate” is the current exchange rate at a given point in time. The forward exchange rate comprises the current rate used for a foreign exchange transaction in the future.

Exchange rates change with the demand for a particular currency rising or falling.

Here an example: A trader buys 1.30 US dollars for 1.00 Euro. If the euro rises, it can receive more dollars if it repurchases the dollar, but it can only exchange the US dollars it has already bought for euros at a loss.

Currency Pairs

In Forex trading, a currency pair is a currency which is exchanged into another currency. The first currency is referred to as the base currency, the second as the quote currency. The base currency is the currency purchased.

Currency pairs usually consist of the US dollar and other currencies because the US dollar is the most traded currency on the currency market.

If a currency pair consists of two major currencies without the US dollar, one also speaks of currency crosses. For example, currency crosses with euros, yen or pounds are possible.

The currency pairs are displayed in the so-called “chart”. For example, if it says EUR/USD 1.35, a trader must pay 1.35 US dollars to receive one euro.

The top 5 currency pairs are:

EUR/USD

USD/JPY

GBP/USD

USD/CHF

USD/CAD

How Forex Trading Works

The largest market participants in Forex are banks, industrial companies or professional foreign exchange brokers and trading houses. However, private forex traders and retail investors can also participate in the market.

Earning Money with Forex

How much capital does a trader need to trade Forex? There is no minimum or maximum number that can be recommended. Ultimately, the amount of capital invested depends on how much risk a trader wants to or can take. The entry into the Forex trade, however, is already possible with a few hundred dollars.

The return on Forex trading consists of the difference between buying a currency and later selling it again. In principle, the calculation of the yield in a Forex Trade is not as simple as with a conventional investment, for example in fixed-term deposits. Also, the fees for Forex brokers, through which access to the foreign exchange market is only possible, must be deducted from the yield. Fees can be commissions or Forex spreads. It should further be noted that the income with trading Forex is subject to tax.

Those who invest larger sums of money can make high profits, but Forex Trading should not be seen as a substitute for an income from a regular job. However, private retail investors can use Forex trading to supplement their income.

Time Investment

Forex trading is time-consuming. For this reason, too, beginners should consider beforehand how much time they can spend on their foreign exchange transactions. Most Forex brokers help to develop strategies that can, in turn, help to generate profits. However, the high risk of forex trading remains, and the average Forex newcomer will usually incur losses initially, as trading currencies is very complex and subject to significant fluctuations.

It is therefore highly recommendable to start with a demo account with a Forex broker to get a feel for the currency market. After initial attempts with virtual capital and getting a better understanding of losses and gains, beginners can move on to investing real money in forex trading.

Important Principles

If you want to enter the FX Market responsibly, you should adhere to firm principles. It includes that a trader only invests as much as he could bear as an actual loss. Besides, the motto “buy low, sell high” has also proven its worth. For example, if the US dollar is very low against the euro at the moment, traders should buy dollars, because the exchange rate is expected to rise again.

 

Forex Glossary – Important Technical Terms

 

Forex broker

They are the link between private forex traders and the forex market. Individual investors can buy and sell currencies through them. Today Forex brokers can also be so-called trading platforms in the form of software. These programs are used to organize the purchase and sale of currencies.

 

Leverage

Leverage can multiply and magnify profits and losses in margin trading. The broker offers traders various levers that they can use. Depending on the size of the leverage, corresponding securities (margins) must be deposited.

With leverage, a trader borrows money from the Forex broker to enter into larger positions. It needs to be highlighted once again that leverage can lead to significant losses in a very short time and should, therefore, be treated with caution!

 

Spread

A spread is a type of fee that the broker charges for each trade. The spread is calculated from the difference between the purchase and sale value of a currency. So-called “spread mark-ups”, are typically used by brokers that act as a “market maker”, which means that they determine the prices/spreads and not the market itself.

 

Margin

Margin is a kind of security deposit that a trader deposits with a broker for a trade. The margin defines how high the maximum leverage can be. If the margin at a stake of 10,000 dollars is one per cent, the trader must deposit 100 dollars with his broker.

 

Pip (price interest point)

The pip is a unit that is used for foreign exchange trading. It can be used to indicate the price change of a currency pair.

 

Lot

Lot is a unit in trading. One lot usually stands for 100,000 units. If two lots are traded on the USD/EUR currency pair, the bet is 200,000 US dollars.

 

Forex Trading Tools

There are several tools and features that can simplify foreign exchange trading. These tools are available as software for PCs and MACs or as online-based systems. Also, some FX tools can be used as a browser plugin or mobile app. Due to the large number of products, a clear recommendation is difficult. It is recommended to test some tools and trading platforms to find the best one for you. Technical analysis tools range from basic to advanced charting programs, indicators, Forex trading robots and automated trading strategies like Expert Advisors (EAs) which are a very popular add-on for MetaTrader 4 (MT4), a widely used Forex trading platform.

 

Advantages and Disadvantages of Forex Trading

Advantages

High liquidity on the market

Trading takes place directly between market participants

Trading hours are flexible, as trading is possible 24 hours a day

No large starting capital required

High yield opportunities

Flexibility: option to trade from anywhere via the Internet    

 

Disadvantages

Time-consuming

Good knowledge necessary

Long familiarization period

Very high risk

Leverage effect can also be negative

Sharp fluctuations in profits and losses

 

Forex traders must be aware that they can make high profits, but also very high losses (often higher than the start capital if no negative balance protection). The risk in foreign exchange trading is high, even with comprehensive market knowledge, because of high market volatility.

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