What is forex trading?
Forex trading is the means through which one currency is changed into another. When trading forex, you are always trading a currency pair – selling one currency while simultaneously buying another. Each currency in the pair is listed as a three-letter code, which tends to be formed of two letters that stand for the region, and one standing for the currency itself. For example, USD stands for the US dollar and JPY for the Japanese yen. In the USD/JPY pair, you are buying the US dollar by selling the Japanese yen. Some of the most frequently traded FX pairs are the euro versus the US dollar (EUR/USD), the British pound against the euro (GBP/EUR), and the British pound versus the US dollar (GBP/USD). To keep things ordered, most providers split pairs into the following categories:
◆ Major pairs- seven currencies that makeup 80% of global forex trading. Includes EUR/USD, USD/JPY, GBP/USD and USD/CHF
◆ Minor pairs- less frequently traded, these often feature major currencies against each other instead of the US dollar. Includes: EUR/GBP, EUR/CHF, GBP/JPY
◆ Exotics- a major currency against one from a small or emerging economy. Includes: USD/PLN, GBP/MXN, EUR/CZK
◆ Regional pairs- pairs classified by region – such as Scandinavia or Australasia. Includes: EUR/NOK, AUD/NZD, AUD/SGD
Most forex transactions are carried out by banks or individuals by seeking to buy a currency that will increase in value against the currency they sell. However, if you have ever converted one currency into another, for example, when traveling, you have made a forex transaction.
How does forex trading work?
Institutional forex trading takes place directly between two parties in an over-the-counter (OTC) market. Meaning there are no centralized exchanges (like the stock market), and the institutional forex market is instead run by a global network of banks and other organizations. Transactions are spread across four major forex trading centers in different time zones: London, New York, Sydney, and Tokyo. Since there is no centralized location, you can trade forex 24 hours a day. Most traders speculating on forex prices do not take delivery of the currency itself. Instead, traders will make exchange rate predictions to take advantage of price movements in the market. The most popular way of doing this is by trading derivatives, such as a rolling spot forex contract offered by IG. Trading derivatives allows you to speculate on an asset’s price movements without taking ownership of that asset. For instance, when trading forex with IG, you can predict on the direction in which you think a currency pair’s price will move. The extent to which your prediction is correct determines your profit or loss.
The three different types of forex market:
√ Spot forex market: the physical exchange of a currency pair, which takes place at the exact point the trade is settled – ie ‘on the spot’ – or within a short period of time. Derivatives based on the spot forex market are offered over-the-counter by dealers like brokers.
√ Forward forex market: a contract is agreeing to buy or sell a set amount of a currency at a specified price, and to be settled at a set date in the future or within a range of future dates
√ Futures forex market: an exchange-traded contract to buy or sell a set amount of a given currency at a set price and date in the future.