What is Forex Trading? An Explanation
The foreign exchange, or forex, market exists to allow the global trading of international currencies. By aggregating buyers and sellers, the market establishes the relative value of each currency against a range of other currencies.
Currency conversion is essential to facilitate international trade, but the forex market also enables direct speculation on the relative value of individual currencies. That is, it allows traders to buy and sell specific currencies with a view purely to making a profit.
When a currency is strong in the forex market, it is generally trading at a high exchange rate against other currencies, and its price is generally rising. When a currency is weak in the market it is generally trading at a low exchange rate against currencies, and its price is generally falling.
The forex market consists of a range of forex pairs. Each pair represents the exchange of one named currency into another named currency. For example, the pair GBP/USD represents an exchange of sterling into US dollars. Currency values are always relative, as the price of one currency can only be determined in another currency.
If you’re new to forex trading, the forex pairs you’ll probably pay most attention to are EUR/USD, GBP/USD, USD/JPY, EUR/GBP and other so-called ‘major’ pairs. These are typically the most heavily traded pairs, although there are also a large variety of ‘minor’ or ‘exotic’ pairs allowing you to speculate on the strength of currencies such as the South African rand or the Hungarian forint.
Spread betting or CFD trading
InterTrader provides two ways to get involved with the forex market: spread betting and CFD trading. Both methods allow you to speculate on forex prices without having to make a physical purchase or sale, and both allow you to maximise the use of your investment capital.
Spread betting lets you buy or sell any forex pair for a certain amount relative to any movement in the price. For example, you might buy EUR/USD for £10 for every ‘pip’ movement (a pip is the smallest trading unit of the quoted price), meaning that you will make £10 for every pip the price rises (if the euro is strong against the dollar) and lose £10 for every pip the price falls (if the euro is weak against the dollar).
This is a simple way to track your profit and loss against the movement of forex prices, without having to convert amounts from one currency into another. Find out more about spread betting.
CFD trading replicates more fully the process of exchanging one currency for another. You open a contract which represents a trade of a given amount in the forex pair. For instance, with InterTrader, 1 CFD of EUR/GBP represents an exchange of €10,000 into sterling.
Say you buy 1 CFD of EUR/GBP at 0.8481, this represents an exchange of €10,000 into £8481. If you later sell this CFD at a price of 0.8692 (i.e. £8692) you would make a profit of your selling price (£8692) minus your buying price (£8481) which equals £211. Find out more about CFD trading.
With both spread betting and CFDs, you don’t have to deposit the full value of your trade to open your position. For instance, to open the above CFD you only need a fraction of the full £8481 on your account, intended to cover your potential loss. This gives you leverage, in that you can increase the rate of return on your initial capital, compared to making the equivalent physical trade in the forex market.
You should note, however, that this leverage similarly increases your level of risk, and that you can lose more than the initial deposit you use to open your position.