What Is Forex & How To Get Started? Many people involved with “forex” don’t actually understand what it is or why it exists. This tutorial should give you at least some insight into how and why it works the way it does…
Forex stands for “FOReign EXchange” – the idea that you’re able to exchange currency for another currency. Like exchanging your money while traveling to a foreign country to their currency.
We are talking about a vast sized market. The whole premise of the system is that you’re able to profit from the estimated $6 TRILLION in daily exchanges between currencies.
The reason why the forex market has grown over the last two decades because of the promise that you’re able to profit from the constant fluctuations in the prices of different currencies.
Imagine, during your holiday the price of the currency changes so you can win or lose some money. Due to another advantage of the banks` playground is that commission is much lower, and for that reason, the “sell” can go higher than the “buy” price during a holiday. So when you exchange the rest of your cash you got more money than you paid for it.
Everybody requires currency to live, and as such the volatility in the prices of many of the world’s most substantive currencies is substantive. What’s more, it’s also the case that if you have “macro” economic factors influencing the price, you’ll end up with a plethora of opportunities to make a profit from the purchase/sale of the various pairs.
What is FOREX
In a nutshell, “Forex” is swapping one currency for another. If you have USD, you may wish to “purchase” GBP or EUR with it. The point is that by purchasing another currency, you are essentially betting that the “base” currency (USD) will drop in value, leading you to get more USD for the EUR if / when you wish to transfer it back.
The way this works is through something called a “currency exchange”.
Just like with going on holiday, you can use a central arbitrar to buy other currency from. In the case of retail / travel, you’d do it with a “travel agent” – but in the financial world, you’ll talk to a “currency broker”.
Currency brokers work just like stock / shares brokers. They provide clients with the ability to invest into “currency pairs” – which are basically the equivalent of a “stock” / “share”.
Currency pairs (USD/GBP GBP/EUR) are designed to provide traders with a simple way to manage their holdings – allowing them to swap their currencies through the broker with impunity. This is basically what “currency trading” is – swapping currencies between two or more different pairs to get a profit (or loss), depending on how those pairs performed…
You’ve likely already done this before, if you’ve ever travelled to a foreign country or have used the likes of Paypal to accept foreign currency payments. You’re essentially swapping a currency for another. Apples for oranges.
The reason this is important to appreciate is that “Forex” has no underlying asset base from which you’re able to quantify an investment.
With stocks, shares and other commodities – there are quantifiable indicators of the price that the investment should be able to yield. However, “forex” is entirely driven by the economies of the various areas that issue / trade with the legal tender you’re looking at.
How To Trade Them
The most important thing to consider is that if you’re looking at “trading” currencies, you have to be able to understand the trading process…
As mentioned, professional forex trading works by providing users with the ability to determine the differences in price that occur between currency pairs.
This happens for a multitude of reasons, but as a base level – it’s dictated by the “exchange rate” of different currencies. For example, $1 might exchange for £1.30. This exchange rate means that if you purchase $100 worth of GBP, you’d have £130 in your hand.
Say something happened to the UK’s economy and the value of the GBP dropped significantly against the dollar; the new exchange rate would be $1 = £1.05. This means that if you purchased $100 worth of GBP, you’d end up with £105.
The point here is that if you placed the original trade, you’d actually be in a much better position when the price of GBP dropped. Your holdings of £130 would equal $123.80. This difference (IE the ability to end up with more USD than you started with) is where profit comes from with the Forex system.
To this end, if you’re looking at getting involved with the forex world, you have to appreciate that income / profit is NET of capital deployed. The example above would mean you’ve made $23.80 profit on a $100 investment. You did not make $123.80, that was the gross return.
This is extremely important actually.
The profit you make will typically be 2-5% of the capital you deploy. Be under NO illusion – Forex is NOT a get rich quick scheme; it’s a genuine method of wealth management… but you have to have a core understanding of how real economics work.
This means that if you’re looking at the market, it works just like any other – you need capital to deploy, and then you need to be able to use that capital effectively. In the case of forex – it means buying currencies when they’re valued low and then selling them when they’re valued highly…
As mentioned, the way to “trade” forex is to go through a broker.
Financial brokers – such as IGMarkets – have direct access to exchanges and markets to provide traders with near-instantaneous settling of their trades. The important thing to note here is that these businesses give you near-wholesale rates for your currency exchanges.
Retail institutions – such as travel agents – basically add extra exchange points to boost their profits. They justify it by saying they only handle small amounts so need to keep their business stable and reliable. Larger outfits can afford to it much cheaper.
Essentially, if you want to “trade” forex, you have to use a broker – who’ll provide you with the ability to buy currencies of your choice. They’ll allow you to track “currency pairs” and then provide you with the ability / functionality to make the transaction that you require.