What is Forex? A Beginner’s Guide To The Mechanics Of Forex

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What is Forex? Strictly speaking, Forex is short for Foreign Exchange, which is the activity of exchanging one currency for another. This can be simply for the purposes of buying something from another country, or to have the valid currency on hand on your travels. However, in recent times, Forex has become a vehicle for financial speculation just like stocks, bonds and futures.

Trading Forex is very attractive because it’s a highly liquid market that’s in operation 24 hours a day, 5 days a week. In recent times, with the uncertainty surrounding stock trading, many investors and speculators have turned to Forex as their trading vehicle of choice. Forex trading can be very lucrative because it involves a high degree of leverage, but there’s a significant risk involved as well. So if you’re interested in Forex, here’s what you should know before you open your first trading account.

How Does Forex Work?

If you look at the price quotes of any foreign currency, you’ll notice that they are displayed in a “pairs” format. For example, there’s the AUD/USD, EUR/USD and USD/JPY to name a few. This format tells you what the trading price of one currency is relative to the other. In the case of the EUR/USD, this is the price of the Euro in US dollars. For example, if the EUR/USD is trading at 1.5450, this means that one Euro can buy 1.5450 US dollars. For this pair, the Euro is what is called the base currency, and the US dollar is what is called the quote currency.

Typically, the currency prices will only fluctuate by one or two cents a day at most. So how do you make money off such a small change in price? This is where leverage comes in. When you buy a “unit” of foreign currency (commonly called a contract), you don’t have to pay the full purchase price, like how you would if you were buying stocks. Instead, you’re trading on margin where you put down a deposit of a percentage of the full contract price to control the contract. Normally, one contract is worth 100,000 of the base currency. It’s very common to see 50:1 or 100:1 leverage being offered by Forex brokers, which means that you only need to put up a deposit of 2,000 of the base currency to control one contract.

The smallest quoted change for any traded currency pair is called the “pip”, which stands for percentage in point. For most currencies, except the Japanese Yen, a pip is one unit of the fourth decimal point. In the case of the Japanese Yen, a pip is one unit of the second decimal point as the Yen is commonly valued at about one hundredth of most other currencies. For example, if the EUR/USD were trading at 1.5000 and it went up to 1.5015, it would be said to have risen by 15 pips. For a standard contract that is worth 100,000 of the base currency, each pip is worth 10 of the quoted currency. So if you were to trade one contract of the EUR/USD for a profit of 15 pips, your profit would be 150 US dollars.

Trading Forex For Fun And Profit

So what does this mean for you if you want to trade Forex? Basically, the normal rules of investment and speculation apply. You buy low and sell high, or you sell high and you buy low. So if you wanted to back the Euro to rise against the US dollar, you would buy or “take a long position” in the EUR/USD. However, if you wanted to back the US dollar against the Euro, you would take the opposite position, meaning that you would sell or “take a short position” in the EUR/USD.

Of course, if picking profitable Forex trades were easy, then every one of us would be millionaires by now. The reality is, there is a lot of strategy, skill and risk management that goes into the profitable trading of Forex. So just because you know “what is Forex” doesn’t mean that you’re ready to trade Forex. To give yourself the best chance of success in this area, I highly recommend that you study the basic Forex trading topics covered on this site before you proceed.

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