How Forex Trading Operates

How the Currencies are Paired and Traded Online

You can start forex trading by buying and selling currencies simultaneously in pairs through a dealer or broker. For example, USD can be paired with the JPY or EUR as follows: USD/JPY, USD/EUR. The British pound can also be paired with Swiss Franc – GBP/CHF.

The exchange rates between the two currencies in each pair keep shifting as the market forces change. The paired currencies are like two bulls fighting, and you buy or sell the pair depending on which “bull” you think is stronger.

The most traded currency pairs in online forex trading are referred to as the majors, and they are the most liquid and most profitable in the forex trading market. These majors most often have the USD on either side:

  • USD/EUR, EUR/USD, GBP/USD, USD/GBP, JPY/USD, CHF/USD, USD/AUD, NZD/USD, AUD/USD, etc.

Currency pairs without an USD element to them are referred to as cross-currency pairs or crosses in short. Pairs that do not have the U.S. dollar but have EUR, GBP and JPY are the most traded crosses, e.g. EUR/GBP, JPY/CHF, CHF/GBP, EUR/CHF, AUD/JPY, etc.

Exotic currency pairs are those that contain one major currency and a currency of one of the emerging economies such as Mexico, Hong Kong, Saudi Arabia, Hungary, or Brazil.

The U.S. Dollar is the most traded currency in the forex market, followed by the Euro, Yen, Pound, Australian dollar, Swiss Franc, and the Canadian dollar respectively.

It is important to pay attention to the U.S. dollar when trading because it makes up 62% of all the forex reserves of the world. Remember that the U.S. has the largest, strongest, and one of the most stable economies in the world. The U.S. Dollar is also used in most countries as the preferred medium of exchange in international business.

Speculation and Liquidity = Convenience and Profits

Forex trading, unlike stock exchange, is basically an Over-the-Counter business occurring electronically 24-hours a day. The forex market is spread across the world, and you can trade anywhere on the planet as long as you can go online.

Another thing that a forex trader needs to consider is liquidity. This concept refers to how quickly the trade is moving over the counter, or the number of transactions involving money at a particular time.

Forex trading often occurs through speculation, whereby traders buy and sell currencies based on the movement of prices within a day. Considering the large volumes of forex trades executed in a day, the liquidity of the market is often high. The high liquidity is good for traders because it shows that the prices can change easily within a certain period of time. Thus, a trader can make quick money in a short period.

That is one reason to invest in online forex trading; but hold your horses…there are risks. Continue following our lessons to understand how to deal with such risks comfortably.

Various ways of Trading Forex

Forex trading is splendid! God bless whoever started the business. How did Forex trading start anyway? That is a story for another day. For now I will tell you how you can have fun while speculating or investing in currencies.

The most common ways of trading currencies are: Options, spot forex, futures, and exchange-traded funds (ETFs).

Futures

Currency futures are contracts to buy or sell currencies at a given price on a specified date in the future. This form of forex trading is well regulated and transparent because it pertains standardized contracts entered into based on readily available information.

Options

This type of financial instrument entails having the right, yet no obligation, to buy or sell a currency for a given price when the option expires. Options are less liquid than futures or spot markets, and there is a limitation of market hours.

Exchange Traded Funds (ETFs)

Currency ETFs are concerned with one currency or a bundle or group of currencies traded in a financial institutions in form of a fund. The financial institution offers shares for each fund to members of the public in an exchange market, allowing investors to buy or sell the shares. They involve transaction costs and commissions, and are subject to time limits.

Spot Market

This is what I like, what you like… the real deal. This is the home of online forex trading. As the name suggests, it entails buying or selling currencies on the spot. The spot market has several advantages – liquidity, global operations for 24 hours on a working day, simplicity, and tight spreads.

It is easy to trade forex on the spot market because accounts can be opened easily with a relatively small amount, although too small is not advisable. You will understand why later in the course.

So, forex spot market is what we do; it is our game from here henceforth…

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