The Beginner’s Guide to Forex Trading, The Currency Markets and Currency Pairs
Forex trading is not a very easy thing to do. However, you can learn how to do this in forex education, just like everything else. Welcome to the very first part of your lesson in how the market works. You will learn everything of importance, including currency pairs, and how you can trade the respective currencies. The forex market revolves around currency and how you can profit from it. Go through our forex broker reviews to pick the best broker.
To start you off, forex trading is a speculative investment where you trade two currencies against each other and get the benefits from the difference which exists in the exchange rates of the currency pair, over time. Did you get that? It is so easy.
However, that is not all. We are going to go through forex education after this brief introduction. You will be able to get what the market is all about and, hopefully, start your education into becoming a good trader.
As a newcomer, the market can be tough, mostly because newcomers tend to think that the market is some sort of get-rich-quick scheme. That is not at all the case. You have to work hard for the money.
You have to learn so much in forex education, understand currency, currency pairs, and other graphs details, and know when to make the right decision. Every choice has a consequence, and that is very well reflected in the forex market.
In forex trading, you will need to understand many of the terms, the way things work, and the procedures. In this article, we are going to introduce you to what the currency market does and how you can get into it.
Understanding The Forex Market
In forex trading, the currencies are the assets, and they are all sold in the same marketplace. However, the forex market is not located anywhere in a physical location. It is a virtual market with several tiers, and the location is linked to all the computers of the liquidity providers (usually the banks).
The banks constitute what we call the Interbank FX Market. It is at this level where central banks from governments, also operate. They are responsible for the printing of money and the controlling of monetary policy.
As you will come to find out, any announcements by central banks have are something you will want to take seriously. If you want to survive in the forex markets, information is everything.
The other tiers include:
- Hedge funds
- Institution traders
- Retail brokers
- Prime brokers
There are others too, and you will come to know about them as you advance in your forex trading. Look through the forex broker reviews to get the best brokers.
You will find the retail forex traders at the very end of this tier system. Their job is to give orders and executions that are then handled by the retail forex traders and ECN/STP brokers.
As you can see, this currency market is decentralized, because there is no physical location. Everyone who is a participant is connected to the forex trading market in one way or another, through their currency trading platforms.
The Main Characteristics of the Forex Trading Market
To understand the forex trading market better, let us sum it up using the characteristics that make it what it is:
- All trading must be done with the currency pairs
- Forex trading involves a buyer and a seller (two parties)
- The forex trading market is leveraged
- There are always two prices quoted for the currency pair (the ask price and the bid price)
- The forex trading market is a zero-sum market and any money lost, is gained by some other trader on the opposite side of the trade
These are the unchangeable facts that describe this market in a way that is accurate and makes sure that you never lose sight of how everything here works.
Contrary to how stocks and other assets are traded on their own, the currency markets need to be traded in pairs. That is why we have currency pairs in forex. The rate at which we exchange a currency does not fluctuate all by itself. It has to be compared to another currency.
Take this example:
You can use one Euro to buy a certain amount of dollars at a specific rate. However, soon after that, you can exchange the US dollars you acquired earlier for more Euros, or sometimes even less than you initially used for the original transaction.
Co, currency pairs are all about comparing one currency with another and then knowing the difference in exchange rates between them after a given amount of time. That is what we call forex trading. It always has to be done using currency pairs.
The forex market has more than 100 currency pairs. We divided these currency pairs into major, minor, and exotic currencies in forex trading.
So, let’s break the currency pairs down:
- All the major currency pairs feature the USD (United States Dollar). These are the most traded currency pairs, and they make up almost 85% of all the forex trading volume in the forex trading They tend to have low spreads because of high liquidity.
- The minor currency pairs are also known as crosses or cross currency pair They do not typically contain the USD and are derived by pairing with the Japanese Yen, the Euro and the British Pound.
- The exotic currency pairs tend to have wide spreads and have low trading volumes. These currency pairs feature emerging market currencies from countries like Russia, Poland, Norway, Mexico, Sweden, and Brazil, among others.
When it comes to writing currency pairs, we mostly use abbreviations that look like this: USD/EUR or EUR/USD or CAD/JPY and so on. The 3-letter abbreviations on the left side of this pairing is what we call the base currency and is expressed as a single unit.
The 3-letter abbreviation on the right is called a counter currency, and we show it as the price we see in the price quotes. The way that they relate to one another is something we will explain in the subsequent paragraphs.
Abbreviating Currency Pairs
We abbreviate the currency pairs using three letters. The first two are the name of the country where the currency originates. The last one is taken from the name of the currency. Most of these last letters tend to be the first letter of the name of the currency, but not always.
To make this well understood, here are examples:
- Let’s start with the Dollar which originates from the United States of America, we will take the US as the first two letters and then the D from the word ' Dollar,' will become the last of the three letters.
- NOK is the abbreviation used for the Norwegian currency. We take the NO from the name Norway and the K from Krone, which is the name of the Norwegian currency.
- The British use the Great British Pound. As with the others, we take the GB from Great Britain and the P from Pound. That is how we end up with GBP.
Forex trading is much easier to understand when you know these little and necessary details by heart. You can look at the full list of abbreviations of the currency pairs by searching for them on Google or any other search engine of your choice.
Understanding Two Prices In a Quote of Currency Pairs
You will find that every currency pair has two prices listed. These prices are called the BID price and the ASK price. Here’s what each of them means:
- The BID price is the price stated to the left of the quote.
- The ASK price is the one stated on the right of the quote.
The difference between these two prices is what we call the spread. The spread is the broker's compensation, which is deducted as soon as you order a trade.
We can write the price quote for the EUR/USD currency pair as 0.01014/1.01021.
NOTE: Not too long ago, the pricing system for currency pairs was changed to a 5-digit decimal, from a 4-digit decimal, to make the pricing more accurate.
The 5th digit in the sequence is a tenth of the 4th digit. So, for this price quote, the spread of the asset is read as 7.0 pips and not 70 pips.
Moving on, the bid price is the price at which the sell order should be executed, and the ask price is the price at which the buy order from the trader, is executed.
Prices are always quoted in terms of the number of units of the currency on the right of the currency pair (what we call the counter currency), which can be sold or bought from the single unit of the base currency on the left.
If we quote that the AUR/USD is 1.11088/1.11091, that is taken to mean that a single Euro can buy 1.11091 USD or can be sold for 1.11088 US Dollars.
From this, we can say that to the left of the price quote, we have the number of units of the counter currency (which is on the right) that can buy one unit of the currency to the left. Conversely, the price on the right of the quote (which is the ASK price) represents what one unit of the base currency (the one on the left), can buy.
It is that simple. From here, we move on to the forex trading part of this whole thing. How do you trade the currency market?
Learning How To Trade the Currency Market
You can earn money from forex trading by buying the currency that you think will increase in value in relation to another, or you can sell a currency that you think will drop in value when compared to another currency. This is simply known as the type of long and short order of trading.
Long means you buy and short means you sell.
- There are many kinds of orders in the forex trading You can use the market order where it’s just market buy, market sell, to go long or short, using the currency price of a currency pair.
If you want to go long or short at rates different from the ones in the market, we call that a pending order which has a buy limit, sell limit, buy stop, and sell stop. To sum this up:
- A limit order is suitable when you expect the price to move against the chosen direction before it continues on its course. This is used to buy or sell at a cheaper price than the market offers.
- A stop order is suitable when you want to buy or sell at a price that is typically ahead that of the market. Traders use this to buy or sell at a price higher than the current market price. However, it is at a rate which confirms that the price will continue to move in the predicted direction without stalling at what we call support or resistance levels.
Just for reference, you can set trade volume (also called lot sizes) or the leverage for any trade. To understand the numbers, we have the Standard Lot, which is equal to a lot size of 1.0, which has a volume of 100,000 units of the trader's account currency.
The size can further be subdivided into mini-lots and micro-lots. A mini lot is equal to 10,000 units, and the micro lot is equal to 1000 units. These can be divided further, as you will come to find out in your forex education.
If you are new and you need to learn which brokers are the best, go through our forex broker reviews.
You will need a forex trading account to get into the currency markets. You will get a broker who will provide it for you. The process requires registration for an account on their website, and you will be good to go. Our forex broker reviews will guide you if you want to pick the right broker.
As you will find out, there is a lot to learn in forex education when it comes to the forex market. For that reason, the amount of educational material is almost voluminous. However, you will find it made easy if you access the right content written by experts, who will show you only what you need to know.
Above all this, you will need experience in order to be able to trade in the forex market effectively and hopefully make money in the long run. Forex education will not be enough.
Welcome to the currency markets, and hopefully, you will begin forex trading in a few months, armed with the right knowledge, an excellent broker, and a sharp mind. For good brokers, go through our forex broker reviews.
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