Forex is always quoted in pairs, in terms of one currency versus another. Take for example GBP/USD (sterling vs US dollar) - the fluctuations in the exchange rate between these two is where a trader looks to make their profit. The first currency, also known as the base is the one that you think will go up or down against the second currency, which is known as the quote.
When trading currencies, you can speculate on the future direction of the market, taking either a long (buy) or short (sell) position depending on whether you think the currency’s value will go up or down. Forex price movements are triggered by currencies either appreciating in value (strengthening) or depreciating in value (weakening).
The Euro is the base currency and the US Dollar is the quote. If the price of the EUR/USD pair is 1.06325 it means that 1 euro is equal to 1.06325 dollars.
If the number increases, this means that the Euro is getting stronger compared to the US Dollar.
If the number decreases, this means that the US Dollar is getting stronger compared to the Euro.
Buying – Going Long
When trading currencies, you would buy a currency pair if you believed that the base currency will strengthen against the counter currency, or the quote currency will weaken against the base currency.
So, if we think that the Euro will strengthen against the US Dollar then we would place a buy trade or go long. For every point, or pip, the Euro rises against the Dollar, we will make a profit. It is important to remember that should the price of the euro weaken against the US Dollar, we would make a loss for every pip it falls.
Selling - Going Short
Alternatively, you would sell a currency pair if you believed that the base currency will weaken in value against the counter currency.
If we think the Euro will decrease in value against the US Dollar we would place a sell trade and for every pip the Euro falls against the US Dollar you will make a profit.
Should the value of the euro rise against the dollar then you will make a loss for each pip it rises.
Forex is a margined product Also known as leveraged trading, this means you can put up a small amount of money to control a much larger amount. This means you can leverage your money further but it also means that losses will be magnified as well, so you should manage your risk accordingly – please ensure that you fully understand the risks of leveraged trading. Which currency pairs? Commonly traded currency pairs are traditionally divided into three groups related to popularity and liquidity: majors, minors and exotics. At most brokers, you can trade over 65 currency pairs including majors, minors and exotics. Majors These are the most liquid currencies (most actively traded) constituting about 85% of total trading volume in the FX markets. The spreads for these are usually tighter compared to the less traded minor currency pairs.
Minors These are not traded as heavily as the major currencies, and so tend to fluctuate more often. Spreads for minor currency pairs also tend to be wider due to the medium sized liquidity in the market, as compared to major currency pairs.
Exotics These are currency pairs that are only very rarely traded. Due to the low volumes of trade, exotic currency pairs are illiquid and tend to be expensive to trade with wider spreads. Many traders view exotic currency pairs as having higher risk profiles compared to commonly traded currency pairs.
Why is leveraged Forex trading popular with investors?
Trade on rising and falling markets trade on falling markets (going short) as well as rising markets (going long)
Leveraged product use a small amount of money to control a much larger position
Volatility | currency prices are constantly fluctuating with each other offering frequent trading opportunities
24 hour trading an OTC product, not restricted to physical exchange hours
Liquidity | spreads tend to remain tight meaning your dealing costs remain low
Forex trading is ideal for people who are:
Looking for short term opportunities. FX prices are also influenced by economic and political conditions, such as interest rates, inflation, and political instability, such conditions usually have only a short-term impact, so FX trades are typically held open for a few days or weeks, rather than over the longer term.
Making their own decisions on what to invest in. Looking to diversify their portfolio.