If you’re looking for a different asset class beyond traditional stocks and bonds, you may have looked at a forex trading company, or foreign exchange market trading, which is essentially the trading of currencies from around the world. This is a very lucrative market for traders because it is very liquid, leverage is heavily used, and it is also the largest market by volume in the world. Trillions of dollars of currencies are traded everyday around the world. So, if you are thinking about getting started with forex trading, here is what you need to know.
How Forex Trading Works
The foreign exchange market works by trading currencies in pairs against one another. Each currency pair is an individual product and is usually written as EURUSD or EUR/USD. In this case, the pair would be the US Dollar and the Euro. The first currency is considered the base currency, and it is quoted relative to the second currency, or counter-currency.
For instance, if EURUSD was 1.5000, it means that 1 Euro is equal to $1.50 USD. This is also how exchange rates are commonly quoted worldwide when you go to a bank or money teller. It is also important to note that most FX quotes are quoted out to 4 decimal points, which is known as a pip (or 1/1000 of a percentage), which also allows for minimal price movements to equate to bigger profits.
Finally, there is the carry trade, which is one of the most popular ways for individuals to trade forex. The carry trade is based on the fact that every currency in the world has an interest rate attached to it, and these rates are set by the central banks of those countries. The idea is that the trader goes long the high interest rate currency, and short sells the low interest rate currency. In this scenario, you would profit on the difference in yield between the two countries interest rates. This is a great way to just get paid for holding a currency pair.
It is important to note that forex trading is very risky since it is leveraged and prices can change dramatically overnight. Forex trades almost 24 hours per day, so a big change can happen overseas while you are sleeping, and you can wake up to your position being liquidated.