How Currency Trading Works
The interest of people in trading forex is increasing. Let’s understand how currency trading works with examples, its popular terminologies & how to start.
Table of Contents
The scope of currency trading is increasing day by day. Currency is a popular financial instrument and the representation of a country. One can make a significant amount by investing money in different currencies. In this article, we will practically understand how currency trading works, its popular terminologies and find out if currency trading is profitable.
What is Currency Trading?
Currency trading is the process of buying and selling currencies in order to take advantage of their exchange rate fluctuation and make money.
In stock trading, a trader invests in a financially sound and growing company, so whenever the value of stock increases, he can also earn profit.
Similarly, while trading currencies, traders invest in an economically sound and growing country by purchasing their currencies.
Understanding how currency trading works
Currency trading always takes place in a pair; to buy one currency, you have to sell another. Some popular currencies are US Dollars, Great Britain Pounds, and Japanese Yen.
The currencies are represented in three-letter codes like USD, EUR, JPY, GBP, etc., where the first two letters represent the country and the third letter represents the currency.
For example, GBP/USD is a currency pair where GBP is a base currency, GB represents Great Britain, P represents Pounds & USD is a Quote currency, where US represents the United States, and D represents Dollars.
For trading in currencies, knowledge of exchange rates is a must. The rate defines the difference in the value of currencies, and it changes continuously due to different economic, political and social factors.
The current exchange rate of GBP/USD is 1.27 USD, which means 1 Great Britain Pound equals 1.27 US Dollars. Let us understand Foreign currency trading with examples.
Suppose you are trading in GBP/USD. If you think the value of GBP will rise against USD, you will buy the pair, or in the opposite scenario, you can sell the pair.
In this case, if your prediction becomes right, you will make a profit; otherwise, you can lose money. So yes, forex currency trading is profitable; you can make significant money. However, like the stock market, the risk of losing money is also there.
Currency Trading Terminologies
We have understood how currency trading works; however, that is not enough. Currency trading for beginners is difficult; therefore, knowledge is a must to succeed.
Here are some popular currency trading terminologies you should know before starting trading.
Long & Short Postion:
These two words are used to define your trade positions; Long Postion is a word used for buying a currency pair in the hope that the price will rise in future, while a short position is used for selling a currency pair speculating that the price will fall.
Ask Price & Bid Price:
The price at which a trader buys a currency pair is known as the Ask price, while the price at which a trader sells a currency pair is the bid price.
Spreads:
It is a difference between the ask and the bid price. It can be defined as trading fees; many forex brokers make money through spreads.
Pips:
Percentage in points or pips is defined as the small change in a price or exchange rate of a currency pair. It is the fourth decimal of price change used to define your profit or loss from a trade.
Suppose you buy a standard lot of EUR/USD at 1.1150 and sell it at 1.1160. In this case, your profit is 10 pips. The price of each pip is 10$ with a standard lot. So your profit will be 100 Dollars.
Lot:
It refers to the unit or group of pair. Generally, eggs or bananas are bought in dozens; similarly, currencies are traded in lots. There are three major types of Lot sizes:
A standard lot of 100,000 units
A mini lot of 10,000 units
A micro lot of 1,000 units
Market Analysis:
Analysis is a way to study and interpret price movement to invest in the right opportunities at the right time. Traders mainly use three types of analysis methods: sentimental, fundamental and technical.
Leverage:
Leverage is the most confusing term. Forex broker provides traders options to the trader to trade in large positions with small capital, known as leverage.
For example, a broker provides the leverage 1:50, which means with an account balance of 50 USD, you can place a trade of 2500 USD.
How to trade in currency
Forex trading is a good option for you if you are a trader or are interested in making money through investing. Here is a step-by-step procedure of how to start trading in forex.
Learning before earning:
The first and most important step to start trading in currencies is to educate yourself about how the forex market works and its key features.
Many beginners make the common mistake of skipping this step. However, you are putting your hard-earned money in the market, and if you trade without market knowledge, the chances of losses increase.
Select a Forex Broker:
To start trading in currencies, you have to open a trading account on a platform like Meta Trader 4 or 5. Also, you need a forex broker through which you can place a trade.
Many brokers in the market provide access to trading in different financial instruments, including currencies, cryptocurrencies, stocks, energies, metals, etc.
These brokers also provide services like education, market analysis, news, signals, and indicators to help you find potential trading opportunities. However, trading with a regulated broker is a must to avoid the chances of scams or fraud.
Identification of currency pair:
The most crucial step is to identify a currency pair you want to trade, considering your capital, risk factor, trade timing, volatility, liquidity, etc. There are three types of pairs.
Major Currency Pair:
There are seven major currencies, including USD, JPY, GBP, CHF, AUD, CAD, and NZD. Major pair is a combination of USD and one of the other six currencies like USD/JPY, EUR/USD, GBP, USD, etc.
Minor Currency Pair:
It is also known as cross currency pair, a combination of major currencies other than USD. Examples: EUR/GBP, JPY/CAD, NZD/CHF, etc.
Minor Currency Pair:
It is a combination of one major and one currency of developing nations. Examples: US Dollar/Singapore Dollar, Euro/Turkish Lira, etc.
Beginners should avoid trading in minor and exotic pairs because these are the riskiest. EUR/USD is the most stable and profitable pair for a novice trader. You can also go for any other major pairs.
Formulate a solid trading plan:
Trading without a plan is no lesser than gambling. So it is important to frame your currency trading strategy considering the risk-to-reward ratio, currency pair, and time frame. A solid plan contains details regarding how, when, what, why and where you place a trade.
There are many strategies in currency trading, including day trading, scalping, news trading, trend trading, price action etc. You can go for the most suitable one based on your need.
Start Trading:
Once you have prepared your trading strategy, you can start trading now. However, remember it is advisable to start trading with a demo account.
Demo accounts are accounts to practice trade with fake money. Place a demo trade and analyze your profit and loss. Once you are well-versed in trading and satisfied with your strategy, you can begin trading by funding your accounts. Remember to only trade with the amount you can afford to lose and be prepared for the worst.
Final Words
Like any other financial trading or business, both profit and loss are involved in currency trading. With proper knowledge, right trading psychology and continuous learning, you can make a significant amount in the forex market.
We had a detailed overview of how currency trading works. However, there are many other things you need to learn before starting trading, including different trading strategies with their implementations, risk management, analytical and other skills.
Learning makes way for earning, so start your trading journey by educating yourself about the market.
