So you have finally decided to leave your day job and become a trader and you are now looking to become rich trading the forex? This might very well happen, but before you jump in, take the time to read this little introduction to get an idea of what you are about to get into.
What is the forex?
The forex or FX stands for “foreign exchange”. It’s a market on which currencies are traded like the dollard, the euro, or the yen. The forex is the world’s largest market with a trading volume of over $3 trillion a day, which also makes it the most liquid.
Apart from its size, the forex distinguishes itself from other markets in many ways. First, it’s a 24 hour market and it closes only for a few hours during weekends, which means that you can trade the forex almost any time. Second, unlike stocks or futures, currencies aren’t traded in a central exchange like the NASDAQ or the CME. Instead, currencies are exchanged electronically between banks in an Over-the-Counter way. One other important particularity is the lack of commissions — but then how do brokers make money? Well, make they profit on the difference between the bid and the ask prices every time a trade is made (see How to Choose a Forex Broker). The table below compares the forex with stocks and futures:
| Forex | Stocks | Futures | |
|---|---|---|---|
| Trading volume | $3.2 trillion | $1.3 billion (NYSE) | About 1 million contracts a day |
| Market hours | 24 hours | A few hours a day 9:30 to 16:00 EST for the NYSE | A few hours a day, depending on product |
| Commissions | Bid-ask spread | Broker commissions | Broker commissions |
| Leverage | Up to 400:1 | Up to 2:1 | Up to 10:1 |
| Liquidity | Very liquid for major pairs | Varies with stocks, but not nearly as liquid as currencies | Average with good liquidity on selected products |
Pairs and Lots
Currencies are traded in pairs of two. The first currency to appear is called the base currency, while the second is called the quote currency. The majority of the trading that takes place in the forex involves a few Major pairs. These are: EURUSD, GBPUSD, USDJPY, AUDUSD, USDCHF, and USDCAD. Since the Majors are the most traded pairs, they are also the most liquid. Other pairs such as the EURGBP, GBPCHF, GBPJPY, or EURCAD are called cross pairs because they do not include the USD as either the base or quote currency.
Forex pairs do not vary very much in value: on a normal day, a pair such as the EURUSD changes only by about 1%. This is why to be profitable traders need to buy very large portions, called lots. The lot is the base element in currency trading. One lot corresponds to 100,000 units of the base currency. For instance, one lot of the USDJPY is worth $100,000. Alternatively, one lot of the EURUSD is worth 100,000€. But don’t get scared, you don’t need that much money to trade the forex because of something called leverage.
Leverage
Leverage is a mechanism which allows traders to control big amounts of money with little money, and with a lot value of 100,000, leverage has become synonymous with forex. Leverage values of 100:1 or more are offered by many brokers. This allows you to start trading with a smaller balance and to profit from very small variations in the price. However, leverage is a double edge sword — if your profit can be multiplied, so can your losses.
Continue to: Getting Started in the Forex Market: Part 2
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