The foreign exchange market is a global decentralized or over-the-counter (OTC) market to trade currencies. Interestingly, there are no physical buildings that function as trading venues for the forex markets but instead are a series of connections made through trading terminals and computer networks.

Introduction

Established in Amsterdam, the foreign exchange market, usually shortened to “forex” or “FX,” has been around for more than 500 years and is the largest financial global market.

It is also the only genuinely continuous and nonstop trading market, open 24 hours a day, five days a week.

Currencies are important because it allows consumers to purchase goods and services both locally and abroad.  In simple words, if a person living in the United States wants to buy cheese from France, then either the person or the company from which the person is purchasing the cheese will have to pay for it in euros.

It means that an exchange equivalent to the US Dollars’ value for euros will have to occur.

Trading for beginners

Forex trading is still relatively new for retail investors as it initially only served large institutions and banks. However, its speculative trading opportunities have contributed to the rise in popularity in recent years.

Professional and individual investors can earn interest on the rate differential between two currencies and can also profit from changes in the exchange rate.

Typically, forex traders refer to central bank interest rates, which is of utmost importance because when the expected rate of interest rates changes, the currency generally follows it.

Because the daily currency fluctuations are usually minimal in the forex market, with most currency pairs moving less than one cent per day, foreign exchange makes one of the least volatile existing financial markets.

For this reason, many currency speculators depend on enormous leverage to increase the value of any potential movements.

Basic forex terminology

The best way to start with forex trading is to learn the language. Here are key forex trading terms to kickstart your journey.

Bid:  The buyer (or bidder) sets the highest price s/he is prepared to pay. It is the price traders will see when selling a forex pair, usually on the left of the quote and often in red.

Ask:  In contrast to the buyer’s bid price, an ask (or offer) is the lowest price a seller is willing to accept.

Spread:  Represents the difference between the bid and the ask price and depicts the actual spread in the underlying forex market and the additional spread added by the broker.

Pips/points:  A pip is a “percentage in point” or “price in point” that refers to a one-digit move in the 4th decimal place made in currency markets. In other words, if one pip is equal to 0.0001, then 100 pips are equal to 1 cent, and 10,000 pips are equal to $1.

Leverage:  Leverage allows traders to trade with much more than their initial capital outlay by putting up a fraction of the full value of the trade. Importantly, however, although traders borrow capital to multiply returns, leverage amplifies gains AND losses.

Margin:  It is the money set aside in an account for currency trade and needed to open a leveraged position. Margin is the difference between the full value of your position and the funds being lent to you by the broker.

Lot size: Currencies are traded in standard sizes known as lots, and the four common lot sizes are standard, mini, micro, and nano.  The size of the lot has a significant effect on the overall trade’s profits or loss.

How does it work

Like any other transaction, forex trading works similarly with the exception that when you make a forex transaction, you are also making a sale in addition to a purchase.

If, for example, you’re investing in USD/AUD, you are essentially selling a certain amount of Australian dollars for American Dollars.

To start trading forex, it’s a good idea for beginners to set up a micro forex trading account with low capital requirements as it has variable trading limits that allow brokers to limit their trades.

Understanding the macroeconomic fundamentals that drive currency values, combined with experience in technical analysis, could help new forex traders become more profitable.