Forex Tutorial: What is Forex Trading?

What Is Forex?The foreign exchange market is the "place" where currencies are traded. Currencies are important to most people around the world, whether they realize it or not, because currencies need to be exchanged in order to conduct foreign trade and business. If you are living in the U.S. and want to buy cheese from France, either you or the company that you buy the cheese from has to pay the French for the cheese in euros (EUR). This means that the U.S. importer would have to exchange the equivalent value of U.S. dollars (USD) into euros. The same goes for traveling. A French tourist in Egypt can't pay in euros to see the pyramids because it's not the locally accepted currency. As such, the tourist has to exchange the euros for the local currency, in this case the Egyptian pound, at the current exchange rate.


The need to exchange currencies is the primary reason why the forex market is the largest, most liquid financial market in the world. It dwarfs other markets in size, even the stock market, with an average traded value of around U.S. $2,000 billion per day. (The total volume changes all the time, but as of August 2012, the Bank for International Settlements (BIS) reported that the forex market traded in excess of U.S. $4.9 trillion per day.)

One unique aspect of this international market is that there is no central marketplace for foreign exchange. Rather, currency trading is conducted electronically over-the-counter (OTC), which means that all transactions occur via computer networks between traders around the world, rather than on one centralized exchange. The market is open 24 hours a day, five and a half days a week, and currencies are traded worldwide in the major financial centers of London, New York, Tokyo, Zurich, Frankfurt, Hong Kong, Singapore, Paris and Sydney - across almost every time zone. This means that when the trading day in the U.S. ends, the forex market begins anew in Tokyo and Hong Kong. As such, the forex market can be extremely active any time of the day, with price quotes changing constantly.

Spot Market and the Forwards and Futures Markets There are actually three ways that institutions, corporations and individuals trade forex: the spot market, the forwards market and the futures market. The forex trading in the spot market always has been the largest market because it is the "underlying" real asset that the forwards and futures markets are based on. In the past, the futures market was the most popular venue for traders because it was available to individual investors for a longer period of time. However, with the advent of electronic trading, the spot market has witnessed a huge surge in activity and now surpasses the futures market as the preferred trading market for individual investors and speculators. When people refer to the forex market, they usually are referring to the spot market. The forwards and futures markets tend to be more popular with companies that need to hedge their foreign exchange risks out to a specific date in the future.
What is the spot market?More specifically, the spot market is where currencies are bought and sold according to the current price. That price, determined by supply and demand, is a reflection of many things, including current interest rates, economic performance, sentiment towards ongoing political situations (both locally and internationally), as well as the perception of the future performance of one currency against another. When a deal is finalized, this is known as a "spot deal". It is a bilateral transaction by which one party delivers an agreed-upon currency amount to the counter party and receives a specified amount of another currency at the agreed-upon exchange rate value. After a position is closed, the settlement is in cash. Although the spot market is commonly known as one that deals with transactions in the present (rather than the future), these trades actually take two days for settlement.

What are the forwards and futures markets?Unlike the spot market, the forwards and futures markets do not trade actual currencies. Instead they deal in contracts that represent claims to a certain currency type, a specific price per unit and a future date for settlement.

In the forwards market, contracts are bought and sold OTC between two parties, who determine the terms of the agreement between themselves.

In the futures market, futures contracts are bought and sold based upon a standard size and settlement date on public commodities markets, such as the Chicago Mercantile Exchange. In the U.S., the National Futures Association regulates the futures market. Futures contracts have specific details, including the number of units being traded, delivery and settlement dates, and minimum price increments that cannot be customized. The exchange acts as a counterpart to the trader, providing clearance and settlement.

Both types of contracts are binding and are typically settled for cash for the exchange in question upon expiry, although contracts can also be bought and sold before they expire. The forwards and futures markets can offer protection against risk when trading currencies. Usually, big international corporations use these markets in order to hedge against future exchange rate fluctuations, but speculators take part in these markets as well. (For a more in-depth introduction to futures, see Futures Fundamentals.)

Note that you'll see the terms: FX, forex, foreign-exchange market and currency market. These terms are synonymous and all refer to the forex market.

Forex Currencies: Ways To Trade

Trading Forex

The majority of currency trading takes place in the forex spot market. In the forex spot market, large banks and other financial institutions trade currencies among themselves either for immediate delivery (spot market) or for settlement at a later date (forward market.) Trades in the forex market occur over the counter, and the minimum size of trades is very large. For these reasons, it has traditionally been impractical for individual investors to trade in the forex market.
However, over the past several years, a new retail forex market has developed. This market allows individual investors and small institutions to trade in the forex market in smaller volumes than those previously available. For the more heavily traded currencies, bid-ask spreads are relatively narrow, and market liquidity can be excellent. Many currency brokerage firms will also allow investors high levels of leverage – in some cases 400:1 or higher. While the use of leverage can magnify investors' potential returns, it is important to remember that leverage also magnifies potential losses. Investors should carefully consider their risk tolerance before employing leverage. (For more information concerning leverage in the forex markets, see Forex Leverage: A Double-Edged Sword. For another viewpoint on leverage, also see Leverage's "Double-Edged Sword" Need Not Cut Deep.)
Because currency brokerage firms vary greatly in their resources, minimum account sizes, available leverage and execution ability, investors should carefully evaluate several brokerage firms before opening a currency trading account. (To learn more, see Forex Basics: Setting Up An Account.)

Derivatives Markets
Derivatives include futures, options and exotic, customizable derivative contracts. While the more exotic derivatives are generally designed for institutional investors, individual investors often use futures and options.

The most popular currency pairs have both futures contracts (that track the currency pair's movements) and options on those futures contracts. Individual investors can buy or sell the futures or the options to speculate on the direction of the currency pair. These futures and options usually feature reasonably good liquidity, transparent pricing and moderate capital requirements. For these reasons, futures or options are a viable choice for individual investors interested in the currency market. (Learn more about this method of forex trading in Getting Started In Foreign Exchange Futures.)

When using futures or options, it is very important to remain aware of the risks involved in using these financial instruments. While large gains are possible, the majority of investors using these securities eventually lose money. Additionally, futures contracts carry the possibility of potentially unlimited losses. Before employing a futures trading strategy, investors should carefully consider their risk tolerance and thoroughly understand potentially adverse price movements.

Exchange Traded Funds (ETFs)
A relatively new addition to the currency trading universe is the exchange-traded fund (ETF). ETFs have been popular vehicles for tracking stock or bond indexes for many years, but ETFs that track currency movements are relatively new. A currency ETF can be bought and sold just like any other stock. Investors who believe the currency is about to rise in price should buy the ETF; investors who believe the currency will decline in value should sell the ETF. One advantage of ETFs is that they may be more familiar to the average investor than the forex or derivatives markets. ETFs also carry stricter margin requirements, so they may appeal to more risk-averse investors. (Check out Profit From Forex With Currency ETFs and Currency ETFs Simplify Forex Trades.)

Indirect Currency ExposureForex investors should know that purchasing foreign securities exposes them to the risk of potential currency movements. Investors with no intention of directly trading foreign currencies, however, can benefit from a better understanding of the links between international currencies – because these currency movements can ultimately affect the value of other financial assets.

Can Forex Trading Make You Rich?

Can forex trading make you rich? Although our instinctive reaction to that question would be an unequivocal "No,” we should qualify that response. Forex trading may make you rich if you are a hedge fund with deep pockets or an unusually skilled currency trader. But for the average retail trader, rather than being an easy road to riches, forex trading can be a rocky highway to enormous losses and potential penury.
But first, the stats. A Bloomberg article in November 2014 noted that based on reports to their clients by two of the biggest publicly traded forex companies – Gain Capital Holdings Inc. (GCAP) and FXCM Inc. (FXCM) – 68% of investors had a net loss from trading currencies in each of the past four quarters. While this could be interpreted to mean that about one in three traders does not lose money trading currencies, that's not the same as getting rich trading forex.
Note that those numbers were cited just two months before an unexpected seismic shock in the currency markets highlighted the risks of forex trading by retail investors. On January 15, 2015, the Swiss National Bank abandoned the Swiss franc's cap of 1.20 against the euro that it had in place for three years. As a result, the Swiss franc soared as much as 41% against the euro and 38% versus the U.S. dollar on that day.
The surprise move inflicted losses running into the hundreds of millions of dollars on innumerable participants in forex trading, from small retail investors to large banks. Losses in retail trading accounts wiped out the capital of at least three brokerages, rendering them insolvent, and took FXCM, then the largest retail forex brokerage in the United States, to the verge of bankruptcy.
Here then, are seven reasons why the odds are stacked against the retail trader who wants to get rich through forex trading.
  1. Excessive Leverage: Although currencies can be volatile, violent gyrations like that of the aforementioned Swiss franc are not that common. For example, a substantial move that takes the euro from 1.20 to 1.10 versus the USD over a week is still a change of less than 10%. Stocks, on the other hand, can easily trade up or down 20% or more in a single day. But the allure of forex trading lies in the huge leverage provided by forex brokerages, which can magnify gains (and losses).
A trader who shorts EUR 5,000 at 1.20 to the USD and then covers the short position at 1.10 would make a tidy profit of $500 or 8.33%. If the trader used the maximum leverage of 50:1 permitted in the U.S. for trading the euro, ignoring trading costs and commissions, the potential profit would have been $25,000, or 416.67%. (For an explanation of how to calculate forex P/L, see How leverage is used in forex trading.)
Of course, had the trader been long euro at 1.20, used 50:1 leverage, and exited the trade at 1.10 to the USD, the potential loss would have been $25,000. In some overseas jurisdictions, leverage can be as much as 200:1 or even higher. Because excessive leverage is the single-biggest risk factor in retail forex trading, regulators in a number of nations are clamping down on it.
  1. Asymmetric Risk to Reward: Seasoned forex traders keep their losses small and offset these with sizeable gains when their currency call proves to be correct. Most retail traders, however, do it the other way around, making small profits on a number of positions but then holding on to a losing trade for too long and incurring a substantial loss. This can also result in losing more than your initial investment.
  2. Platform or System Malfunction: Imagine your plight if you have a large position and are unable to close a trade because of a platform malfunction or system failure, which could be anything from a power outage to an Internet overload or computer crash. This category would also include exceptionally volatile times when orders such as stop-losses do not work. For instance, many traders had tight stop-losses in place on their short Swiss franc positions before the currency surged on January 15, 2015. However, these proved ineffective because liquidity dried up even as everyone stampeded to close his or her short franc positions.
  3. No Information Edge: The biggest forex trading banks have massive trading operations that are plugged into the currency world and have an information edge (for example, commercial forex flows and covert government intervention) that is not available to the retail trader.
  4. Currency Volatility: Recall the Swiss franc example. High degrees of leverage mean that trading capital can be depleted very quickly during periods of unusual currency volatility such as that witnessed in the first half of 2015.
  5. OTC Market: The forex market is an over-the-counter market that is not centralized and regulated like the futures market. This means that forex trades are not guaranteed by a clearing organization, which gives rise to counterparty risk.
  6. Fraud and Market Manipulation: There have been occasional cases of fraud in the forex market, such as that of Secure Investment, which disappeared with more than $1 billion of investor funds in 2014. Market manipulation of forex rates has also been rampant and has involved some of the biggest players. (For more, see How the forex "fix" may be rigged.) In May 2015, four major banks were fined nearly $6 billion for attempting to manipulate exchange rates between 2007 and 2013, bringing total fines levied on seven banks to over $10 billion.
The Bottom Line
If you still want to try your hand at forex trading, it would be prudent to use a few safeguards: limit your leverage, keep tight stop-losses and use a reputable forex brokerage. Although the odds are still stacked against you, at least these measures may help you level the playing field to some extent.

Learning Forex: Long Term Trading and Short Term Trading. Which one do you choose?

Learn forex article will discuss about the style of trading, short term or long term. Among the long-term trading (long term trading) and short-term trading (short term trading), which is better? In general, traders prefer to trade on a daily basis (short term trading) to pick up a few pips profit targets and make trades several times in one day. However, the difficulty is trying to be able to consistently reach your desired profit. Patience to be able to take a 20-30 pips every day and repeat it constantly, will bore you. And finally made a mistake that led to a large floating loss.

Actually, if you can consistently do it - that is by determining your daily target profit - then you will be able to control how your trading and your profit of course. If there is a trend that is long (long term), but the role in a short period of time (short term) is indeed often makes you feel uncertain as to whether this is really dependable. And you never know when a trend will reverse direction, it is certainly very risky because it would threaten the profit you have accumulated. Therefore, very few traders who play for the long term, this may be one cause.