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The ABC of Forex Trading

The ABC of Forex Trading
May 27
13:08 2014

Currencies are of vital importance to a nation because it forms the basis of foreign trade. Forex trading as the name indicates is trading of currencies between nations. Exchange is indispensable if one has to trade goods of other countries and this very need for exchange has made foreign exchange trading the most liquid financial market in the world with an average traded value of around U.S. $2,000 billion per day. It grabs lot of eyeballs and it is very dynamic, buoyant and most volatile in nature. It goes without saying that there is no brick and mortar set up and all the transactions take place electronically. The three ways in which trading is done is spot market, forwards market and future markets. Out of these three spot markets happen to be the largest market. Electronic method has made future market trading a thing of the past and slowly spot market started taking a lead. This is thus a market with both huge potential and huge risk like any other market. Let us see an overview of the foreign exchange market wherein the forex trading takes place.

Forex market also known as the currency market is a global centralised market for trading currencies of various nations. This market determines the relative value of different currencies. It assists international trade and investments by facilitating currency conversion. Modus operandi includes working through financial institutions who later sub divide themselves into even smaller groups called ‘dealers’. Most of these dealers are banks so sometimes these behind the scenes markets are called ‘interbank market’. Its huge geographical dispersion and high trading volume represent the largest asset class in the world hence the high liquidity. It operates 24 hours a day sans weekends. It uses leverage to enhance profit margins depending upon the account size. Endowed with such multitude of benefits it is sometimes rightly considered a market close to perfect competition. This just goes to show the ambit of these markets is mammoth.

Let us in a nutshell see how forex trade takes place. As mentioned it takes place through a broker. Just few clicks are enough to place your order. The broker passes your order to a partner in the interbank market to fill the position. When we close the trade the broker too closes the position on the interbank market and credit the account with either loss or gain. The entire process takes place within a matter of seconds.

As mentioned above there are three ways in which one can trade in forex market namely spot market, future market and forward market. Lets us know about each of these markets in brief.

Spot market: – It is a market where currencies are bought and sold at current prices, which is determined by the forces of demand and supply.

Forward and future markets: Unlike spot markets here currencies are not traded at current prices. In forward markets, contracts are bought and sold Over the Counter between the two parties, who mutually determine the terms of agreements. In future markets, contracts are bought and sold based on a standard size and settlement date on public commodities markets, like Chicago Mercantile Exchange. These two markets act as cushion and risk bearer as they offer protection against currency trading.

Opening a forex brokerage account: Trading in forex market is similar to trading in equity, Similar to opening a trading account in case of equity market,but there are lot of factors a rational investor must keep in mind before selecting a forex account.

How to trade in a forex market:- There are mainly two ways in which one can go about trading in forex markets. One is simply buying and selling of currencies pairs, going long on one and short on the other. The second is purchasing of derivatives that tracks the movement of a particular currency pair. Both of these techniques are no rocket science and bears resemblance to techniques used in equity markets. The first method being the most convenient and common method to adopt.

Types of orders: There are two types of order a trader looks at – market order or limit order. In market order forex trader has the liberty to obtain the currency at the exchange rate which it is currently trading in market while limit order allows forex trader to specify a particular price of entry. When traders hold open positions another tool which can be used is called stop-loss order. This order lets the trader determine how much the rate can go down before the position closes and further losses get accumulated.

Unlike a stock market, a forex market is divided into various levels of access. At the topmost level is the interbank market which comprises of the commercial banks and security dealers. These levels of access are determined by the amount of money one is trading with. This amount is called ‘line’ is forex market terminology. It is interesting to note that the top level interbank accounts for almost 40% of all the transactions. Pension funds, insurance companies, central banks, mutual funds and other institutional investor’s role in increasing in the forex market slowly but surely. It should be kept in mind that almost 80% of the forex transactions are conducted speculative. This implies that the institution or the person who bought/sold the currency has no intentions of taking the actual delivery.

Individual traders also known as retail traders constitute a growing segment all the more with the introduction of retail foreign exchange platforms. At present, they participate through brokers and banks. In this regard it is important to understand the difference between a broker and dealer who is also known as a market maker. A broker is nothing but an agent of a forex trader by getting the best price and doing the trade on behalf of its client. On the other hand a dealer acts a principal is transactions with retail customer and they quote a price in which in are willing to deal at.

Thus we see forex market is a huge universe wherein players from all walks of life can play whether big or small, real or through institutions. It has lot to offer but again at one’s own risk and caution.

The ABC of Forex Trading - overview
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Articles on the Jadenforex blog written by "Jadenforex" include guest posts, and items written in collaboration with several authors.

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