What is Forex Trading

A brief guide on Forex, Commodity and US Equity Indices. This blog covers intro, various aspects and
guidelines on trading and risk management.

Intro to Forex
Any currency other than the locally used one is a foreign currency. It is also commonly referred to as
Forex or FX. For a person residing in the U.K, the U.S $ is a foreign currency and so on. With the
proliferation of the internet and very fast means of transportation, we commonly come across forex over
the course of our lives.

There can be multiple reasons why we deal with foreign currencies:- 

• You may be embarking on a vacation to some foreign country and need its local currency to manage
expenses.
• Some of us get better employment opportunities overseas, so we are paid in a foreign currency.
• The web has enabled people to create many online opportunities which often result in revenue in
the form of Forex.
• Forex traders which include large investment banks, financial institutions, multinational
corporations and speculators try to create opportunities from price fluctuations.

Types of Forex Trading

1. Spot:-
This transaction takes place instantly in cash. You go to a money changer with your local currency
and obtain the desired foreign currency as per prevailing spot exchange rate.

2. Futures:-
Currency futures form the largest segment by trading volume. They are traded in the form of
contracts with pre-defined dates of expiry. A futures currency contract is traded on the basis of
expected future outlook of the foreign currency.

Currency futures are widely used by business entities that have global scale operations and they
aim to hedge currency related risks through them. They may be procuring inputs from multiple
countries. Likewise, their products may be selling at global scale.
The daily traded value of forex futures in is trillions of US $. The market participants are also in
millions each day.

Where and how is Forex Traded

Forex is traded globally almost round the clock for 5 days a week. The trading takes place electronically in
the form of standardized lot size of 100,000 units of any foreign currency. Many electronic exchanges
exist around the world that enables traders anywhere to trade forex. In order to facilitate small investors
and speculators, the currencies can be traded in smaller lot sizes as well. These exchanges are enabled
with electronic trading. Investors manage their trading accounts either from their PCs or smartphones.
Currency exchanges have registered members also known as brokers. Forex traders open currency
trading accounts with any broker of their liking. Whenever an investor trades forex, the broker earns a
commission. Brokers also earn through spreads. Spread is the difference between the bid (selling) and ask
(buying) price of the currency pair. Another probable income avenue for brokers is providing leverage /
financing to traders which is discussed later.

Role of Leverage / Gearing
Leverage or gearing is a key feature of all futures trading avenues. This is a form of financing that is
provided to prospective traders by exchanges or forex brokers. Leverage enables small traders to take
positions in forex pairs far exceeding their actual investment. The level of leverage varies across
exchanges and regions but is generally in the range of 20 to a 1,000 times of one’s invested capital.
Leverage is also known as “Margin” in market jargon.
The level of risk is directly proportional to leverage. Traders need to be very watchful of this aspect.
Leverage acts as one the main attraction for small traders who can magnify earning prospects manifolds
relative to their investment. However, leverage or gearing is a double edged weapon and must be used
with proper risk management. Failing to do so can potentially result in a complete wipeout of one’s hard
earned money.

Forex Trading and how it’s done
Forex is a relative term. You are pitching 2 currencies and valuing one in terms of the other. In forex
trading, currencies are quoted in the form of a pair. One of the commonly known currency pairs is the
EUR/USD. This pair is comprised of 2 renowned international currencies, namely the Euro (official
currency of the European Union) and the American Dollar. We are effectively comparing the worth of 1
Euro in terms of 1 US $. Alternatively, this pair implies the valuation of 1 Euro in terms of US $.
The example of EUR/USD pair is further expanded to better understand forex trading. The price of
EUR/USD is quoted as 1.1658. In this pair, EUR is the ‘base currency’. The quoted price of 1.1658 implies
that 1 EUR is worth 1.1658 US Dollars. This indicates that currently, the EUR is worth more than the US $.
It is pertinent that the pair is quoted up to 4 decimal places. Forex pairs fluctuate very less in percentage
terms but the large lot size results in high monetary impact.

Factors affecting Forex Prices
• Current and future economic outlook
• Political developments
• Data on indicators such as inflation, growth and production etc.
• Military standoffs or confrontations
• Balance of trade