Forex trading is a form of unpredictable trading in which investors and traders use foreign currencies to buy, sell and trade assets through the global network of international central banks. It is an online-based market that provides 24-hour access to markets worldwide. It allows for speculation on the value of currencies against each other or another asset, like gold or oil.
Forex trading typically involves two currencies at a time but may involve more depending on what type of account you have. For example, if you open an individual account with a forex broker instead of a company account, you will be able to trade three different pairs in standard lots (that is, 100k units per pair).
Standard lots allow the forex broker to balance their risk, but they tend to be more expensive because of this. Company accounts typically only allow you to trade in one pair, and it is smaller in size (10k units per pair)
To trade, you need a computer with an internet connection and access to forex trading software or an online platform from your home or office. You can access the platform through a web browser on your computer, log into a mobile device app, or set up alerts if there is an active market for a specific currency pair that you are following closely.
There is no central marketplace
The forex market is not a single centralized exchange but a network of individual participants who already have existing relationships. Instead of having a central location where every transaction occurs, every bank that participates in the forex markets has people on staff, often known as ‘the dealing desk’ or ‘the trading floor’, who either buy from you or buy from you sell to you directly. In many circumstances, this helps to balance the books and facilitate transactions between counterparties.
Transactions are made through different currencies
Because there is no predominant location for the trading, most transactions are made by converting one currency into another before determining an agreed-upon price. Meaning you need to offset your exposure when selling one currency and buying another. For example, if you sell $1 million in exchange for USD at 1.0500, you will have USD 500k leftover, which would cause you to lose money with every additional transaction because of the market spread (the difference between the bid/ask prices).
To avoid this issue, traders buy or ‘go long’ on currencies they think will appreciate against their base currency; conversely, they short or ‘sell short’ currencies they think will depreciate against their base currency.
Retail and institutional participation
Trading in the Forex markets can be done either by an individual or a company (a legal entity representing someone or something). Anyone who trades for their account is known as a retail trader, while investors who use services provided by brokers to access the market are classified as ‘institutional traders’.
The distinction between these two groups lies in the amount of money they have to invest. Retail traders may only have a few thousand dollars to trade, while institutional investors usually have millions of dollars at their disposal.
Margin accounts allow you to trade on leverage
If you deposit AUD 10k into your margin/trading account, you will have access to a maximum of $100k in buying power when trading currencies. Your broker lends you the difference between what you pay for each transaction and what they receive when you sell. The amount that your broker lends you is known as ‘margin’ or ‘leverage.’
Margin accounts must be in good standing to trade
Before allowing clients to trade on margin, brokers perform strict credit checks to ensure their margin accounts can handle additional buying power without defaulting on previous purchases. Although this requires traders to meet specific criteria before being approved for an account, it also ensures participants cannot lose more than their initial capital investment, which reduces the risk associated with trading.
You can trade either from the long or short side of the market
In addition to buying and selling currencies, traders can also enter orders known as ‘limit’, which instruct a broker to buy at a lower price than the current rate or sell at a higher price. It is often done in anticipation that prices will move in your desired direction while asleep or away from your computer. When placing limit orders, traders will place either stop-losses or take-profit limits.