Foreign Exchange or Forex basically means, buying currency of one country, by using the currency of another country. It is also referred to as currency exchange. Forex is largest financial world market, where almost 4 trillion dollars worth of currencies are traded every day. This article is about introduction to Forex currency trading so let’s now briefly understand about Forex trading, and how to do it the right way.
Why Exchanging Currencies
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• To invest in foreign financial assets
• To pay for goods & services in a foreign country
• To hedge unfavorable exchange rates in the future, and to earn profits from the changes
The holders of foreign currencies will have to convert the money back into their home currency, and take the profits.
What is hedging
Hedging means exchange of currency in spot markets, or using future contracts for protection against adverse potential changes. Majority of hedgers are businesses and governments that trade with foreign countries.
Speculators are traders, who exchange currency just for profits. Governments generally make use of central banks to sell or buy foreign currencies, thus influencing the exchange rate to some extent. Thus, the currency rates will swing when the demand and supply of each currency fluctuates, against another currency.
How Forex market works
FX market is generally an over-the-counter marketplace. There is no central exchange marketplace. Network of dealers like central banks, corporations, commercial & investment banks, Forex brokers, and also individuals, are active participants in this market. Transactions are conducted electronically, usually online. Traders make transactions through a brokerage trading platform.
Therefore, FX market operates as a spot market. Even though there are futures and forward currency contracts, most of the Forex trades use spot market. Exchanges and brokers are positioned from all around the world, so FX market is open for 24 hours on weekdays.
Currencies are handled in pairs, and many broker sites display real-time currency quotes. Currencies of five countries are traded most actively, they are :
1. USD (United States Dollar)
2. EUR (Euro)
3. JPY (Japanese Yen)
4. GBP (Great Britain Pound)
5. CHF (Swiss Franc)
Exchange rate is basically, the amount of foreign currency that is needed for buying one unit value of the home currency.
Advantages of FX trading
• FX market is decentralized, so there is no Government fees applicable
• No clearing fees or exchange fees
• Market is open for 24 hours on weekdays.
• Market size is large, so liquidity and transactions are fast
• Currency investment is a good strategy to diversify the assets, because it does it impact the bonds or stocks directly.
• Decentralization and sheer size of FX market makes it impossible to manipulate the prices by accounting frauds
• Large markets cannot be cornered, or insider trading is not possible (because it is not operated by a single organization)
Forex metals
Metals like gold, platinum, silver and palladium can be traded through FX accounts. Generally, Pip spread is 2-3 times more than the equivalent future contracts, so the desk brokers will charge their own prices on FX metals. Trader gets to buy or sell metals at broker’s rates, instead of market prices.
FX accounts
You will not have to make huge investments to open a FX account, but of course you can increase the investments, to increase the overall profits from exchange rates. For example, mini accounts are provided by some firms with 50:1 leverage ratio. Trader with $100 deposit in mini account can trade up to $5,000 worth of currencies. It is the leverage that escalates the amount of profits and losses.
FX trades taxation
Forward currency contracts are classified under 1256 contracts tax code. The profits and losses through FX spot market are considered as ordinary income, except that the taxpayer avoids taxes.
Two ways are used to report the FX trade profits and losses in the spot market. One is the default method governed by IRC 988 under which FX taxes are considered as regular income. In the other method, the trader opts for 60% long term or 40% short term on the gains & losses. It is a beneficial alternative, because long term profits are taxed at low rates, than the ordinary profits. Now you know more about Fx trading by this introduction to Forex currency trading so lets learn more about fundamental and technical analysis.
What is the right way to conduct currency exchange trades
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Market analysis is an essential part of FX trading, so that the traders are able to make the right speculations. There are 2 approaches for doing the market analysis.
1. Fundamental analysis – Here the trader studies the geo-political factors, major financial events, economic news, interest rate changes, GDP, and policies, as they can affect the currency values
2. Technical analysis – In technical analysis, the traders will use various trading tools and indicators to study the historic & current currency values, and also the volumes of currency trading exchanges.
By using both the approaches, traders are able to project the direction of currency price movements, and identify the trading prospects.
Fundamental analysis
Factors influencing the currency values, like interest rates, overall financial state, geopolitical stability, government & central bank policies, GDP, growth rates, manufacturing rates, etc, must be considered.
• Economy – The economic recession in 2008 had affected different countries differently. Different countries responded to these challenges by using diverse investment strategies.
Changes due to economic events and responses, local economical conditions due to changes, affect individual currency values. Events having a negative effect on economies have a tendency to shrink the relative values of currencies, and vice versa.
• Political imbalance – Politically stable countries issue all the major currencies. However, when the political stability gets disturbed, it dramatically affects the currency values. Therefore, it is vital to do fundamental analysis of political stability, related to a preferred currency pair.
• Government policy – Money related policies issued by the Government can have a significant affect on the nation’s currency value. Increase in interest rates curbs inflation, and decrease in rates stimulates economies. High taxes slow down the economic growth, and low taxes can encourage economies.
• Observing other participants – Participants like Governments & central bank, hedge funds, private & financial institutions, and other factors, affect the currency prices. Also, hedge funds or central banks can buy currencies at escalated prices.
• Financial reports & economic events – Reports related to regional financial conditions like the GDP, inflation rates, trade balance and employment rates, interest rates can impact currency prices. Timings of these reports are important to recognize their impact on exchange rates in advance, so that the traders can adjust their trading strategies accordingly.
Technical analysis
Exchange rate charts are used to study currency price movement in FX market. Charts are available online, and are applied extensively by traders. Formats used in Forex charts include:
Bar chart – Experienced traders visualize market movements by looking quickly at bar charts. An in-depth study helps to identify the trends, price support & resistance levels, repeating cycles, and more.
Candle stick chart – Trained traders use candlestick chart to identify visual patterns that signal possible trend changes.
These trading tools and indicators provide traders with the perspective that is necessary to ensure that their trade decisions are right, thus maximizing their profits.
Forex Currency Trading Infographic
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The ForexSQ advice for the beginners would be to learn everything about what is Forex trading technical and fundamental analysis, because it will become your road-map for long term success.
