As a beginner in the forex world, you must be well-versed in the functioning of the global currency market, which generates over $7 trading volume daily. The forex market is recognized as the largest and most liquid trading market in the world, which is also a decentralized space where all trading activities happen online without any centralized exchange. Being a new trader, you must start your journey by learning about the history of the forex market, as it gives you an overall idea about how to navigate the market easily. In this article, we will explain everything about the forex market and how to trade forex in a beginner-friendly way.
Table of Contents
What is Forex?
Forex trading is about anticipating the exchange rate fluctuations in currencies, by which you buy and sell international currency pairs to make profits from the trade. Forex traders can buy one currency and simultaneously sell another or speculate on the value of a single currency rising or falling against another currency.
For example, a trader might buy the Euro and sell the US Dollar if they believe it will increase relative to the dollar. Alternatively, a trader might sell the Euro and buy the US Dollar if they think the Euro will decrease in value relative to the dollar. Forex trading can be conducted by individual retail traders, financial institutions, and corporations and can be done through a forex broker and online trading platform.
Trading in the volatile forex market involves high risk and requires a thorough understanding of the market and its dynamics. Traders have to use various technical and fundamental analysis tools to help them make profitable trading decisions. In fact, the learning curve for a first-time forex trader can be a prolonged one, as it takes time and patience for a total beginner to becoming a skilled trader.
History of the Forex Market
The foreign exchange market, commonly known as Forex, is a market that is open all the time as the market hours are divided into time-zone-specific trading sessions. Hence, you can trade forex anytime from anywhere as the trading activity continues until the weekend. In short, the forex market is wide awake 24 hours a day and five days a week. Although it may be a new concept to some, the practice of exchanging currencies has been around for a considerable amount of time, evolving and growing to become what it is today.
The origins of currency exchange can be traced back to 259 BC in Egypt, marking the earliest known evidence of this practice. Over time, the Forex market continued to develop, and in 1944, the Bretton Woods Accord was signed. This agreement allowed currencies to fluctuate within a tightly controlled range.
In 1971, a free-floating currency system was implemented, creating the modern-day forex market. Shortly after that, the same year, computer monitors replaced the outdated telephone and telex methods. The 1980s saw the advent of electronic Forex trading, enabling traders to engage in real-time trading.
How do Exchange Rates work?
Exchange rates represent the value of your currency compared to another currency. Essentially, it’s the amount you must pay to obtain a particular currency. Forex Traders are responsible for determining the value of most currencies. They engage in trading activities around the clock. In 2019, the daily volume of trades in this market amounted to a staggering $5.1 trillion. A strong currency is beneficial because it enables you to purchase more other currencies, which is particularly advantageous in commerce and trade.
The market value of currencies constantly fluctuates, and numerous complex factors contribute to this. Although governments and banks do not directly regulate currencies, they may attempt to influence exchange rates. Ultimately, the value of a currency is closely connected to the economic performance of its country of origin, as well as the interest rates set by the central bank and the supply of that currency in circulation, along with the aggregate demand for the currency.
Buy and Sell to Make a Profit
- Bid and Ask Prices in Forex Trading
In the foreign exchange market, trading involves both Bid and Ask prices. The Bid price refers to the amount traders are willing to pay to buy a currency, while the Ask price refers to the price at which traders want to sell the currency.
- Long and Short Positions in Forex Trading
A long position in forex trading is when a trader buys a currency expecting its value to rise in the future. In this scenario, traders buy low and sell high, hoping to make a profit. On the other hand, traders can also go short or sell a currency, hoping its value will decline, allowing them to repurchase it at a lower price. This approach is known as short selling, where traders sell high and buy low and can profit from market trends moving both upwards and downwards.
When going short, it’s crucial to work with brokers specializing in this type of trading, as not all brokers are geared toward short selling. Therefore, it is essential to find suitable brokers for short selling.
Buying and holding currencies with the expectation of a change in their value is known as currency speculation. Traders purchase a particular currency if they believe it is undervalued and wait for its value to increase to make a profit. Conversely, if they believe a currency is overvalued, they resort to short-selling it.
In 1992, during economic instability marked by low interest rates and high inflation, the British government raised interest rates to boost the pound’s value. George Soros, a hedge fund manager, observed this move and decided to short the pound, resulting in what is now known as “Black Wednesday.” As a result, the British government withdrew its currency from the European Exchange Rate Mechanism (ERM), incurring massive losses.
George Soros became a renowned currency speculator/ forex trader after earning $1 billion from this deal. However, it’s essential to remember that successful speculations like these are the work of exceptional traders, and not all currency speculations yield such results. George Soros is also the author of many renowned books on forex trading, which serve as educational resources for beginners. ‘Alchemy of Finance’ is one such book by Soros, which can be an insightful read for newbies exploring the forex space.
Risks of Forex Trading
- Market Volatility: Forex trading is highly volatile, and sudden and unexpected price movements can lead to significant losses. Various factors, such as political events, natural disasters, and economic releases, can cause volatility. Therefore, traders must be prepared for sudden market moves and have a risk management plan.
- Leverage Risks: Leverage is an essential tool for forex trading but also increases the risk potential. Trading on margin means that traders can control a larger position than their account balance. While leverage can amplify profits, it can also amplify losses, leading to significant account drawdowns or margin calls.
- Technical Issues: Forex trading relies heavily on technology, and technical issues can occur anytime. These can include platform outages, slow execution speeds, or connectivity problems. Such issues can lead to missed trading opportunities or erroneous trades, resulting in losses.
- Psychological Challenges: Forex trading is mentally challenging, and traders need to manage their emotions effectively. Fear and greed are common emotions that can lead to poor decision-making, such as holding onto losing positions for too long or entering trades without a solid strategy. Discipline and emotional control are crucial to successful trading.
- Black Swan Events: Black Swan events are rare but significant events that can profoundly impact financial markets. These can include natural disasters, geopolitical crises, or unexpected economic events. Such events can cause significant market volatility, leading to losses for traders who must be adequately prepared.
In short, entering the forex market as a trader opens up many profitable opportunities for you to explore. But you will also be exposed to the market risk arising from the volatile and unpredictable nature of the forex market. However, those who learn to deal with and manage the risk well can go a long way using their techniques and skills. Surviving in the forex market requires a solid understanding of the market dynamics and trading concepts, so take it slow and trade responsibly until you get well-versed in the complexities of the ever-changing forex world.