Forex is a huge market where trillions of dollars are traded every day with the involvement of thousands of traders from all over the world.

Originally foreign exchange trading (forex trading for short) was a business for the central banks, commercial banks and other large and medium financial institutions. But gradually it has become more and more popular among small speculators because of its potential for individual profit from investing a relatively small amount of money.

Read more to find out the basic facts about forex trading, and how it compares to the more familiar stock trading.

Foreign exchange (forex)

In the past, the main use of currency was to buy necessary goods and services. But gradually with advent of international trade and the globalization of business a new concept started to develop – trading currencies for speculative gain.

Previously, only investment banks and hedge funds could access this potentially profitable opportunity, but recently the availability of online forex broking services has opened up forex trading for small traders.

How does it work?

Foreign exchange trading is all about buying one type of currency in exchange of another. The trade occurs depending on a value comparison between the two currencies that are about to get exchanged. For example, if you compare EURO with US dollar you will see that the value of 1 EURO is equivalent to 1.3984 US dollar. So if you want to buy 1 EURO you will have to spend 1.3984 US dollar. However the value of one currency against another frequently changes due to economic, financial, political and other reasons.

When you are trading forex, if you think that the currency pair price is declining, you sell, and if it is increasing, you buy. You don’t need to buy first, then sell (this is called going long). If you want you can sell first, and then buy later (this is called going short). The buying and selling closes out the position.

Here EUR/USD= 1.3984 means you can purchase 1 Euro in exchange of 1.3984 US dollar. When you close the trade, you realise a profit or a loss (although your broker will also keep track of where you are at all times). For example, if you have bought the EUR/USD currency pair for 1.2000 USD and sold it for 1.3500, you have made a 0.15 USD profit through this trade.

Forex trading vs. stock market trading

There are some basic similarities that exist between forex trading and stock market trading. In case of the stock market you buy a particular stock for the lower price and sell it at a higher price to make a profit. In the forex market as you buy a currency pair for a lower price and sell it in a higher price. The basic trading mechanisms are similar, but if you compare these two markets you will see that there are many differences.

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Tags: beginning forex, forex introduction

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