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How Forex Works and What are Pips and Lot in Forex?

How Forex Works and What are Pips and Lots in Forex?

how forex worksAs you already know what forex is and the different ways to trade forex, now, let’s focus on how does forex trading works. Although it is not rocket science, you will need to know the steps.

How Does Forex Work Step By Step?

Forex is a currency exchange marketplace. People here either sell or buy currencies from different countries. There is no complexity in it like other trading markets, as at FX, you exchange one currency with another one by checking on recent trends. Here is how forex trading works.

Step 1: Find the Best and top Currency Pairs

First, research to find the best and top currency pairs. The best pairs to trade are pairs that contain a huge amount of volume and liquidity. Also, the best pairs should have a high bid-ask spread. This is important because the bigger the spread, the more profitable and lucrative the trade.

Step 2: Open A Trading Account

Once you have identified the best currency pairs, open a trading account. You can do this through a broker or an online forex trading platforms. However, you may also find the broker first and then look for the currency pairs to trade. You can see our best forex brokers list to pick the best one.

Step 3: Start Trading

At this point you re ready to start trading. Start by looking at the currency pair’s chart you intend to trade. Also, determine the trend of the currency pair.

Step 4: Identify the Trend

Identify the trend of the currency pair you intend to trade along with the trend’s direction. However, if the trend is down, sell short. If the trend is up, buy long.

Step 5: Open A Position

Once you’ve identified the trend, open a position in the currency pair. To open a position, first, place a limit order. This is where you set a price that you are willing to sell for or buy for.

Step 6: Close A Position

After placing your limit order, wait for the price to move in your favor. When it does, close out your position by placing a market order.

Step 7: Continue Trading

Continue trading. The key to trading is to never stop trading. Always be looking for opportunities to trade.

Forex platform offers everyone to come and trade with a tiny amount as low as 25 USD. When a trader makes a currency quote like USD/EUR, where the base currency is USD, and EUR is the quoted one, he believes that the value of EUR will increase as compared to USD. By keeping a traded amount at FX, he will earn a profit by selling them later.

Here, all money making depends upon the exchange rate which is merely the ratio of one currency to another. One either buy or sell the base currency. And it goes like, the base currency is the one which should get high as compared to the quoted one, so that one can make money.

An example to state that – Mr. X bought 10000 Euros (EUR/USD) at an exchange rate of 1.1800, later after three weeks he sells the euros to repurchase USD, and now, the exchange rate has become 1.2500. This changed exchange rate has earned him 700 USD as profit. EUR 10000 X 1.18 = 11800 USD (When he bought currency pair) EUR 10000 X 1.25 = 12500 USD (When he sold the currency pair with updated exchange rate). He earned a profit on your base currency, i.e., USD, you invested 11800 USD (by exchanging them for euro), and you got 12500 USD, 12500-11800 = 700USD.

How Forex Market Works?

The forex market is a global market that allows traders to buy and sell currencies based on the expectation of future price changes. It is open 24 hours a day, 7 days a week, and allows traders to make transactions in real-time. Currency pairs are traded between two parties and are considered contracts of exchange.

What is a Pip in Forex?

Time to study some mathematics, don’t worry it is not as hard as an algebra but needs serious attention and concentration; it is advised to not jump into trading before knowing this.

So, what does pip stand for in forex?

In the world of Forex trading, as per pip definition, pips in trading mean the smallest unit of currency in a foreign exchange market. In forex, it means percentage in point or price interest point. In most cases, Pip values are updated every 10 seconds, so they can be used as a real-time reference for pricing actions.

Pips in Forex is the measurement unit which is used to determine the change in values of two currencies when compared together. Other names like Pipettes or Lots also know for this trading unit. Pips in Forex are used to calculate the movement or value of currency whether trades are rising or shattering. Usually, a pip is the last digit of the price quote; a pair is compared up to the four decimals.

At FX which is a vast and giant trading market, even 1/10th value of a pip matters a lot and gets considered as pipettes. Pips are calculated as per the currency it gets used for. Every currency carries its respective value based on which the calculation of the pip takes place. The values next to the two highest numbers in the traded value can determine pipettes.

After all this brief introduction, one important question which you may think to ask is how to find the pip value in my account (if trading on FX)? Answering this question, the first thing which one has to do is to convert the given traded value in their base currency. After that multiply or divide the given pip value by the exchange rate of your quote. If found pip value and traded currencies are the same then there is nothing much to do.

What Is 1 Pip In Forex?

One pip is ten-thousandth of a cent. In forex, most of the currency pairs represent pip as 0.0001. For example, a 2-pip spread will be 1.1051/1.1053, or the difference of the last digit of a price movement.

What Is a Lot in Forex Trading?

In the early day of trading, investors traded Spot Forex with a fixed number of currency units which a trader could use for buying or selling. These fixed amounts were known as lots.

In simple words, a lot is a unit of measurement used in forex trading that is equivalent to 100,000 units of foreign currency.

So, if you want to know what is 1 lot in forex, here is your answer.

Initially, a lot was always 100,000 units of currency (standard), but with time, forex has introduced some other lots like a mini lot (10,000 units), a micro-lot (1,000 units), and a nano lot (100 units).

Forex brokers use either these lots or the actual currency units to measure the trading quantity. Nowadays, forex brokers consider pip values for selling and buying currency units. Earlier, profits and losses have a calculation on the basis of lots when there was a minimum limit to the trading quantity at Forex.

However, the scenario has changed with the spread of internet availability in every corner of the world paving for all the trading enthusiasts to try their hand at trading irrespective of the trading amount which can be as low as 25 USD.

Forex Order Types

Know Forex Order TypesThere are many different types of forex orders used when trading forex. Forex orders are a way to execute trades in the foreign exchange market. They offers investors with the buying ability of different currencies top generate a reasonable amount of profit. Forex orders can be placed through a broker, through an automated system, or by directly giving instructions to your broker.

They define the terms of trade and specify the actions traders will take. An order can be either buy or sell or any combination thereof. Some of the most common forex order types are:

  • Market Order – Forex market order types allows a trader to deal (buy or sell) at the best available price at Forex. Sometimes, due to the volatile nature of the forex market, the final executed price may differ from the trader’s selected price.
  • Limit Entry Order – This order allows a trader to sell at a certain price which is above the market price or buy at a particular price which is below the market price.
  • Stop Entry Order – This is a vice-versa of above-stated order type. This type of order facilitates the trader to buy at a specific price which is above the market price or to sell at a specific price which is below the market price.
  • Stop Loss Order – This order linked to a trade acts as a shield to protect the trader from incurring additional losses when the exchange rates move in an unfavorable direction. In a long position, it’s called sell STOP and in the short run position, it becomes buy STOP.
  • Trailing Stop Order – This is similar to stop loss, the only difference being it moves when the market prices swing.
  • Weird Forex Order – Few traders like to place unrealistic and taboo sort of orders, often considered as Weird FX Orders.

A few other FX order types go with these names – One-Triggers-The-Other Order, One- Cancels-The-Other, Good for the day, Good’ Till canceled. These are rarely placed orders as most of the FX trade happens with the above 5 orders.

Forex Demo Trade

Demo trading platforms can be compared to the support wheels attached to a bicycle which enable the kids to learn and eventually gain confidence in the process of riding a bicycle. The support wheels are let go once the kids had enough practice and learned the basics of cycling. Similarly, new traders can utilize the various demo trading platforms to learn forex trading’s mechanics and test their trading skills until they gain the confidence to put real money in the market.

The demo accounts are replicas of real trading accounts which allow the aspiring traders to trade but with zero risks and zero money involved. Forex demo trading is an excellent way to learn about the market before investing real money. It’s also a good way to practice your trading skills and to get a feel for how the markets work. There are many benefits to Forex demo trading, including learning how the market works, developing trade skills, and getting a feel for market conditions.

It’s crucial for a serious individual who to trade on forex to spend a good amount of time to learn and understand the patterns, terminology, pros-cons and rhythm of the Forex market. Forex demo trade accounts help in getting the feel of the real- time action and learn how market rates can take sudden u-turns plunging from sky high to rock bottom.

By providing you with free demo trading accounts, the brokers increase your interest and get you for serious so that you can eventually start trading with real cash. Ideally, a person should spend around three to twelve months on these accounts to reach a stage where profits are consistent.

As a novice trader, you should focus on one currency pair and should stick to it till you learn all the trading aspects. Once you find that you are confident and studied enough, then you can start real trading with small amounts in the beginning.

Basic Forex Terms

Forex trading is a complex and challenging business. And many people have zero or less understanding on different terms used in forex trading. This can lead a trader to frustration and sometimes even worse performance.

The following part will enlighten you about some forex trading lingo and help you to understand them.

  • Base currency: Base currency refers to the currency that is used as the foundation for all other currencies in the forex market. It is also known as the reference currency.
  • Quote currency: This term is used to describe the practice of quoting foreign exchange rates in terms of domestic or base currencies
  • Currency pairs: It is the pair of currencies you can trade in forex. You can trade currencies in pairs only. The two most popular currency pairs are EUR/USD and GBP/USD.
  • Bid price: The bid price in forex trading refers to the price at which a certain currency or commodity is offered for sale by the dealer. This price may be quoted in dollars, yen, euros, pounds sterling, or any other currency.
  • Ask price: It is the price at which a trader or forex investor is ready to sell a particular currency pair.
  • Spot rate: The spot rate is the current price of the currency. It’s the rate that you’ll be quoted when you are buying or selling a currency.
  • Exchange rate: The exchange rate is the rate at which one currency can be exchanged for another.
  • Foreign exchange market: It is the online place or market where a trader will buy and sell currencies. You will be able to access this market through an online broker.
  • Margin: It is the amount of money you can take the risk on each trade.
  • Margin call: This is when a broker demands that you deposit more money into your account to cover losses that you’ve incurred.
  • Trading account: You will need to open a trading account with a broker to initiate forex trading. You will need to provide your bank details to the broker, so they can transfer money into your account.
  • Stop loss: A stop loss is a point at which you will close a trade if the price goes against you. If the price fell you’ll close the trade.
  • Stop loss order: This is when you place a sell order that will trigger a stop loss. You should place a stop loss order if you are trading on the forex market and you don’t want to lose money.
  • Take profit: If the price goes up, you will want to take the profit. You will need to set a take profit, so you can close the trade when the price rises.
  • Leverage: This is the amount of money you can borrow from the forex broker or financial institution to continue your trading activity.
  • Market order: This is when you trade directly with a currency pair. You won’t be able to place a stop loss or take a profit order on the market.
  • Position: This is the overall amount of money you have invested in a forex trading, perhaps in a particular currency pair.
  • Spread: This is the variance between the price of one currency and another.

These forex lingos are necessary to know to understand forex trading.

8 Comments

  1. Anish Niraula 1 on August 16, 2019 at 2:54 AM

    very usefu

  2. 11700706 on August 24, 2019 at 10:47 AM

    Got it

  3. Vinkal on November 26, 2019 at 4:55 AM

    Good information

  4. Samudra on January 12, 2020 at 5:23 AM

    good.

  5. Ranjeeta on January 21, 2020 at 5:21 AM

    It’s very informative.

  6. Dev Ashish Shrestha on August 8, 2020 at 8:42 AM

    The information above about the techniques to make money through Forex is helpful for short-term and long-term investments.

  7. 11800287 on August 8, 2020 at 11:54 PM

    wow I love it.

  8. Subash Banjara on August 18, 2020 at 5:09 AM

    very useful information.

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