The financial news on a nightly basis not only reports on stocks and bonds, but also on currency exchange rates such as the exchange rate between the U.S. dollar and the euro and the British pound. This data isn’t of interest just to those who are going abroad. Foreign exchange traders seek to take advantage of fluctuations in the price of a foreign currency relative to other currencies. Profits may be earned in the foreign currency market, but so can huge losses. Here’s a look at forex trading’s basics.
What Is Forex Trading?
Each day, the value of foreign currencies fluctuates depending on one another. Traders may benefit when there are fluctuations in value. The forex market is a 24-hour-a-day market, and this means it is very liquid. One of the most unexpected aspects of the FX market is its magnitude. The total traded volume per day is $6.6 trillion, according to the Triennial Central Bank Survey of FX and OTC derivatives markets, which was released in the third quarter of 2019. In contrast, the New York Stock Exchange (NYSE) trades on average less than $1.1 trillion worth of stocks per day.
How Forex Trading Works
The comparison with other assets, like stocks, is a good one to make with regard to Forex trading. While forex trading is always done in pairs, as EUR/USD (euro/U.S. dollar) or JPY/GBP (Japanese yen/British pound), there are significant differences in how pairs are formed and executed. When you trade in forex, you may either sell a currency and purchase another, or you can hold the currency until it appreciates in value. The price of the currency you bought will go up, while the price of the currency you sold will go down.
In other words, let’s suppose the euro and the US dollar are exchanging at a rate of 1.40 to 1. Buying 1,000 euros in Euros means you’ll spend $1,400 USD. If the exchange rate is equal to 1.50 to 1 at the time you want to sell the euros, you can get $1,500 by selling them. That yields a profit of $100.
Effects of Leverage
Leverage is often used in the foreign exchange (Forex) market. Traders who have leveraged their initial investments may buy more of their original assets. This is an illustration of how leverage is used by FX traders. With the brokerage company lending them the remaining money, they can purchase $20,000 of foreign currencies for $1,000. It is possible to allow leverage up to 500:1 for certain companies.
In the forex market, leverage enhances both profits and losses. Another way to think about it is if you purchase $20,000 in currency and it increases by 10%, you will earn $2,000. This works up to a 200% return if you have 20:1 leverage and invest just $1,000.
Leverage works both ways, of course. The identical scenario with 20:1 leverage illustrates that, if your $20,000 went down 10%, to $18,000, you would have to pay off your debt to the brokerage company as well as forgoing your whole $1,000 investment.
There is a significant chance of making money in the forex market by following shifts in the currency rate. Gains made in currency markets are magnified by the use of leverage. Speculating and professional trading are often used in forex trading.
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