What is Forex Trading and How Does it Work?
Forex (FX) is the marketplace where various national currencies are traded. The forex market is the largest, most liquid market in the world, with trillions of dollars changing hands every day. There is no centralized location, rather the forex market is an electronic network of banks, brokers, institutions, and individual traders. The forex market is open 24 hours a day, five days a week, except for holidays. Currencies may still trade on a holiday if at least the country/global market is open for business.
Retail traders can open a forex account and then they buy and sell currencies. A profit or loss results from the difference in price the currency pair was bought and sold at.
Forex are listed in pairs such as USD/CAD, EUR/USD, or USD/JPY. These represent the U.S. dollar (USD) versus the Canadian dollar (CAD), the Euro (EUR) versus the USD and the USD versus the Japanese Yen (JPY).
Forex currencies trade in lots, called micro, mini, and standard lots. A micro lot is 1000 worth of a given currency, a mini lot is 10,000, and a standard lot is 100,000.
How to Trade in the Forex
If trader thinks that there will be some upward movement and strength in the currency then they buy forex currencies or in weakness they sell the currencies so they can make a profit.
When a trade buy or sell forex at the current price are called spot transaction.
Forex Forward Transactions
Any forex transaction that settles for a date later than spot is considered as a forward transaction.
Example of Forex Transactions
Assume a trader believes that the EUR will appreciate against the USD. Another way of thinking of it is that the USD will fall relative to the EUR.
Then they buy the EUR/USD at 1.2500 and purchase $5,000 worth of currency. Later that day the price has increased to 1.2550. The trader is up $25 (5000 * 0.0050). If the price dropped to 1.2430, the trader would be losing $35 (5000 * 0.0070).