What Is Forex Trading And How Does It Work?

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Are you interested in joining the Forex market in 2022 but you are not sure on where to start? You have come to the right place. The Forex market is the biggest financial market in the world right now currently boasting a $6.6 trillion average trading volume every day. Once you join the forex market, you can trade and exchange global currencies at any time of the day 5 days a week. However, the forex market is flooded with forex brokers and that is why you need to be careful when choosing a platform especially if you are a beginner. Check out the best forex trading platform for beginners and see which one is the most ideal for you based on their current fees, user reviews, the trading platform, and the regulations.

What Is Forex Trading?

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Forex trading involves speculating on whether the price of a currency will fall or rise so that you can make a profit. Forex trading works almost the same as buying or selling other securities such as stocks. However, with the forex market, currencies are traded in pairs. This means that when you trade forex, you sell one currency and purchase another. You make money if the currency you have bought goes up against the currency you sold.

In order to trade forex, you will need to get a forex broker. Once you open your account, you will be required to deposit some money which is known as collateral so that you can be able to place orders using your broker and to buy and sell forex.

The main task of the forex broker you get will be to execute your orders. The forex broker will act as the principal to your trade and sometimes, they will send your orders to a different market and act as your agent. Working with a forex broker will also ensure that you have access to the market to speculate currency pairs from all over the world.

How Currencies Are Traded In The Forex Market

In the forex market, all the currencies are given a three-letter code. There are about 180 currencies that are recognized as legal tender in the world but the US dollar is the most used during forex trading. The code for the US dollar is USD. Other common currencies often used in the forex market include the EUR, or the euro, the Japanese yen (JPY), the Swiss Franc (CHF), the Australian Dollar (AUD), and the New Zealand Dollar (NZD).

During trading, the currencies being exchanged are combined. For example, you will see a display of currencies such as EUR/USD, USD/CHF, and many others. The USD is mostly involved in many trading’s therefore expect to see it very often.

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How Does Forex Trading Work?

During your research on forex trading, you may have heard forex traders saying that most forex traders are not designed for exchanging currencies. But what does this mean? Well, the forex market is about speculation of future price movements. As a forex trader, you will attempt to buy currencies that you anticipate will increase and at the same time get rid of the currencies that you speculate will go down. Basically, there are three ways of trading in the forex market and these ways were designed to accommodate all the traders, both new and old, and their varying goals.

Let’s look at them in detail.

1. The Spot Market

The spot market is the primary market in the forex market. It is the largest forex market and this is where the bulk of forex exchange happens. This is where currency pairs are exchanged and also, the exchange rates are calculated in real-time based on the current demand and supply.

When trading forex, remember that the spot market is volatile. The rates are often driven by current news and speculation but in the long term, the spot market rates are driven by national economic fundamentals.

Sometimes, the government through the central bank can intervene by purchasing or selling local currency in order to smoothen the market. When this happens, countries with large foreign reserves are usually at an advantage because they have the bargaining power to influence their currency exchange rate.

2. The Forward Market

Instead of executing a trade now, you can also enter into a private agreement with another forex trader and lock in an exchange rate that both of you agree on for a future date. In the forward market, you set the price for an asset for future delivery. Forward contracts are customizable because you can negotiate the length, the size, and the maturity term. The most common currencies traded here are similar to the ones traded in the spot market and they include; the EUR/USD and the GBP/USD. The prices in this market are based on interest rate discrepancies.

3. The Futures Market

The futures market on the other hand is an auction market. In this market, you can buy and sell currencies at a predetermined rate in the future and the exchange rate is specific. As compared to the forward market, where the agreement is private, the futures market is open and the trade is done on an exchange. If you are looking to speculate, then the forward and the futures markets are a good place to start as you are able to see what is happening in the spot market.

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