Trading 101: What is Forex?

Currencies need to be exchanged to conduct foreign trade and business, making foreign exchange markets the largest and most liquid assets in the world! If you want to learn a little more about the pros and cons of forex trading, read our article.

Forex is one of the oldest assets to be traded and is regulated by governments. Before the internet only large multinational companies and hedge funds traded forex as it required high amounts of capital. But thanks to the internet, it is much easier to trade forex, brokers can allow individuals easy access to the foreign exchange market no matter their budget. 

What is Forex?

Forex is shorthand for foreign exchange, and can also be noted as fx, it describes a global market of exchange between currencies. Forex trading covers the highest trading volume of all assets with daily transactions pushing into the trillions! A currency pair/ cross is the exchange rate of two currencies quoted against each other e.g. EUR/USD. The currencies that are traded the most include the U.S. Dollar, the Euro, the Japanese Yen, and the British Pound. 

Forex as an asset class works slightly differently to others as you can earn from differences in interest rate as well as from changes of currency values. You can profit from the difference between two interest rates in two economies by buying the currency with the higher interest rate and shorting the other currency. This is called a ‘carry trade’. 

Forex is most commonly traded as Contracts For Differences (CFDs). CFDs are almost like a bet, where you agree the pair will rise or fall in the market to make a profit or loss. This is different from other ways of trading as you don’t hold ownership of the asset, but instead are deciding which direction the asset will go in a contract with the broker. Forex traders often trade in the short term for profit as long-term trades do not suit its characteristics.

Pros & Cons of Forex

Some people swear by forex due to the following characteristics:

  • Low Volatility: This is because central banks can control currencies demand and supply through monetary measures, to optimize stable exchange rates. 
  • Low Cost: The cost of trading is fairly low with commission commonly at 0.08% of the asset’s value. Other asset classes, including cryptocurrencies have much higher commission rates.
  • 24 hours: The retail forex market opens Monday morning set to eastern time zones and closes Friday night according to U.S. time zones meaning you have 5 full days to trade with! Although the best time is 9am-12am New York time each day. 

The risks: 

  • Unregulated: National banks have varying degrees of regulation meaning forex instruments aren’t standardised across countries. You should check which forex dealers are regulated so you are protected and trade safely.
  • High Leverage: You can sell above the amount of money in your trading account as brokers consider the low volatility of forex. This means you can carry out a large trade with a small account balance at around 100:1! Beware that extremely high leverage can make dealers become insolvent with no notice. 
  • Need specialist knowledge: Having a thorough understanding of economic fundamentals and indicators is necessary to understand how different economies adjust their currency values. It is also key to see how different economies interact as this will affect which currency pairs are more or less profitable. 

Forex trading is great for beginners with low funds who want to be active everyday. For people with larger funds and longer-term horizons forex is not the way to go. If you want to start trading forex we recommend you learn an overview of the macroeconomics that drive different currency values and practice before you invest with BullBear.

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