To understand what a Forex trading is, we must for first explain what a Forex is. The term Forex derives from Foreign Exchange Market and is reffered to as Forex or FX or currency market. It is the market for the trading of the currency, and it involves all the buying and selling among the greater international banks. In particular, a great role in Forex is played by the National Central Banks that should have the role to control money supply or inflation.
So the Forex trading represent the trade of the different currencies. Of course, the trade is to be considered among different countries that have different currencies. Let’s see an example: in the great part of Europe, the currency is the Euro, while in England the currency is the Pound. So, if we buy the Euro and in the same time we sell the Pounds, or vice versa, we are are operating a Forex trading.
Naturally, it is not so simple because, usually, you can not operate by yourself in the forex trading but you have to do it through a broker or throug a market maker. But what you can do is to select the two currencies you want to work on and when you want to do the trading.
Your order can be very fast, as the broker doesn’t need to go somewhere neither to meet any people or speak about the change of currency: everything is done in a couple of click on some terminal that pass your trade to the Interbank Market. So you can gain or loss money depending on the choice of the currency you trade in. In fact the currencies change their relative value during the days, teh week, the months and the year, so, for example, you can buy the pounds in march and sell them in june to obtain a gain. Let’s see how. Consider that in march you buy 2000 euro: you purchase them in pounds so you will spend about 1600 pounds. If you sell these euros when their value is greater, that means the exchange is advantageous, you can sell the same 2000 euro for the price of 1700 euro, that means that you have gain one hundred euro. But if you work vice versa and buy pounds, you have lost one hundred euro.
So if you trust the wrong booker, you can loose money in this ‘game’. The rise and fall of the prices are not casual, but depends on several economics, financial and politics factors, but also on natural events, such as earthquakes, or floods that a good brooker should understand, but that, as it is easy to imagine, sometimes are not predictable. And probably this is the reason for which the forex trading is considered exciting by a lot of people: the trade market is a risk.
We have said that there are no place where operate, neither person to meet: in fact the forex market has not offices neither a location, but operates on a network of banks and businesses that could grow or reduce everytime. This is one of the most peculiar feature of the forex, while the other one is that it operate twenty four hour a day. In fact, it involves the market of all the world that belong to different time zones: it opens on Monday morning, following the time zone of New Zeland (the first country that see the morning on monday) and it close on Friday following the time zone of New York (the last to see the friday evening).
The Forex trading is connected to a several related terms that are used in the forex language and that are fundamental to better understand the Forex itself. Let’s see some of them.
Forex Leverage Definition
The leverage is the increase return on the investiment. This means that when we operate on a Forex, we are working on a leveraged product. Strictly connected to the leverage is the meaning of the risk management. In fact, in the Foreign exchange, you deposit a little percentage of the total value you want to trade and aspect the increase of the return (or better, of the potential return) of this deposit. The leverage allows both the profit and the loss of the Forex to be higher respect to the traditional trading.
Forex Spread Definition
The spread represent the difference between the bid and the ask of two currencies we are working with. It is strictly connected to the Forex as the brokers use the spread to work and make money during the trade. The spread is not very different from the real or actual price: for example, if a price is 1000 and you buy for 1001 and sell for 999 you are always close to the real price, but you have a difference of two (that can be euros, or dollars, or puond or what else) that represent the spread. So, in both case, if you buy or if you sell you also have to consider the spread.There are some more parametres connected to the spread, for example the Pips, the Percentage in Points, that can change a little, not the meaning of the spread, but its way to work with it.
Percentage in Points (Pips) Definition
The percentage in points is fundamental when you work with currencies that have difference in values on the fourth decimal place. So, this in not the case of two currencies that have great relative values, but of those that have a really small differences in values. For example if we have a currency that has a value of 1.44455 and another that have the value of 1.44555, we have a difference of ten pips. From the definition of the Pips, derive that if you have a trade with a positive Pips, you are making a profit, while, if it is negative, you are lose money.
Lots, mini-lots and micro-lots: the unit measurement in Forex trading
There are some terms that are used in the Forex ‘dictionary’ that it is important to know to better understand the Forex topic. One of this is the ‘lot’, that is a term used to refer to an order of 100,000 units. So if we are dealing of one or two lots of a currencies, for example of pounds, we are dealing with one hundred thousand or two hundred thousands pounds. But as in this market we work with pairs of currencies, we can sell a lot of pound and, of course, we are not purchase a lot of euro, as the exchange from pound to euro is not one to one.
So sometimes can be useful to use ‘portions’ of lots. How to obtain them? We must introduce the mini lots and the micro lots, that are used in the same way we use centimetres and millimetres as portions of the metres. A mini lot of a currency correspond to ten thousand of that currency, while a micro lot correspond to one thousand. So, we can trade in mini lots or in micro lots if our trade is not so rich, and we do not arrive to move a lot.
Now we have to go back for a moment to the Pips. Because as the Pips is the percentage in points of the currency we are using, calculated on the fourth decimal place, if we speak in terms of lots, we must realize that the Pips of a lot is different form the Pips of a mini or a micro lot. For example, in the standard lot of the United Sate Dollars (USD), one pip will be ten dollars, while for a mini lot of dollars, one pip will correspond to one USD. The relationship between lots, mini lots, micro lots and Pips for the different currencies is not linear and easy, so that to have an idea of the values is it possible to consult the available on line calculator.
Stop loss Definition
As the name itself suggests, the stop loss is something that stop the losses. To be more precise and using more appropriate words, the stop loss is an order that allow you (or better your broker) to close all your trades in order to stop, or at least limit, the losses. In the moment the order is sent, that means in the same time the broker click on the stop loss option, the trade is closed considering the current market value and it is not possible to chang that value. So, when the market is or seems to be against your trade, you can decide to stop loss to save your remaining financial. Of course, this order is a kind of preserver from a complete collapse, but ask for it is more a strategy than an obbligation. Of course, if you realize that the market is going far from your trade line and in the opposite direction, the stop loss is obliged. Nevertheless, some people can decide to risk, and if the market turns in the right moment, obtain to be save from the loss or, in extreme case, from the failure. Because the real point is that the market is very unpredictable, and even if the trend seems to go to a precise direction, an unexpected event can change completely the way.
Take profit and limit order Definition
The risks of the Forex trading can be kept under control not only using the stop loss order, but also using the Take profit order. This order closes the trade you decide, when you reach in it a desired level of profit. Just like the stop loss order, also the Take profit one allows you to close the trade at the current value that the currency you work with has in that precise moment. It is used when you want to ensure a certan profit, so that, when you reach it, you can feel satisfy with it and decide not to risk tha market turn in the other direction and you lost that profit you have gained. Of course, it preserves you from little losses, but also from the possibility to gain more: in fact, if you close the trade and the market goes on in the right direction, you have no possibilities to gain no more from this. So, in the same way of the Stop loss, the decision to close the trade with a Take profit order is especially a strategy: in Forex nothing is for certain.
Sometimes, the Take profit is also defined as Limit order. Really, they can correspond in some case, but they are not the same things. In fact the Limit order gives you the possibility to close the trade not when you want, because you see that can be convenient in that moment, but when you reach a precise value you have asked for. So this precise value is the limit you can not go beyond, both in right or in the wrong direction, and when it is reached, the trade is closed.
Long and short in Forex Trading
In Forex terms usually used are Long and Short poitions. Let’s see what they refers to. A Long position is given when you buy a currency pair and want (or hope) to sell in a second time to a higher price. In traders dictionary, this is a Long position, also called ‘going long’. On the opposite, going short or be in a Short position, refers to the situation in which the currency pair you have bought falls in the value, so that you are not going to obtain a higher price in selling them, but a lower one.
So usually, when a person buy a currency pair, he do this to obtain a Long position. If he sells, this is because he is going short.
Bid and ask in the Forex
Another couple of terms associated and opposite in the meaning are Bid and Ask. All the quotes in a forex trading have two prices, one connected with the Bid and the other to the Ask. The normal is that the Bid is lower than the Ask, that means that the price of the Bid is lower than the price of the Ask. In particular, the Bid is the maximum price that you (as buyer) want to pay for a currency pair or for a security. On the contrary, the Aask is the minimum price that you, this time as seller, whant to receive, again for a currency pair or for a securety. As the two parametres are not the same, to have an agree in transaction a price is needed that, usually, is in the middle of the two.