It is a puzzle for beginning traders and potential forex investors to draw a mental map and reconcile to the idea of how forex trading works and its glaring complexities.
Honest to goodness, forex trading is an act of speculating. Traders speculate now and then the rise and fall of the prices of currencies. Currencies are bought and sold in pairs. The cost of each currency pair is called an exchange rate. A trader cannot buy currency without selling another currency or sell currency without buying another currency. Put, buy, and sell or sell and buy.
Exchange rates always fluctuate. The speculation of the rise or fall of the exchange rates of currency pairs determines the traders’ time of trading. The traders’ aim primarily is to earn profit from the market movement. To trade currencies, small-time traders look for a broker or sometimes, a dealer to buy and sell currency pairs.
To get a clearer picture of how trading forex works, let’s use as an example the U.S. dollar (USD) as it is the most pegged currency. The U.S. dollar is commonly paired with the Euro (EUR). Assuming that the price of the currency pair of the USD/EUR or the exchange rate is 1.1235, it is understood that a trader will pay 1.1235 euros to purchase one dollar.
On the contrary, if the trader wants to know how much dollars it will cost him to purchase one euro, interchange the currency pair from USD/EUR to EUR/USD by dividing one by 1.1235 (1/1235 = 0.8900) which will yield 0.8900. Hence, the trader only needs 0.8900 dollars to buy one euro. The first currency in a currency pair is called base currency while the other is called counter currency.
Currencies in the market are classified according to their value. There are significant currencies, minor currencies, and exotic currencies.
When one wants to understand why a particular currency is more significant in amount than any other currencies, take into consideration that the value of any coin will always depend on its supply and demand on the market.
Since the price of exchange rates is continually changing, beginning traders should start developing the knack to determine the best time of buying and selling currency pair through practical speculation.
How Forex Market Works
When trying to figure out how the forex market works, imagine yourself going to the market to buy what you are supposed to. Then, the rest is what you imagine it would be: look for the good you are vying for, search (perhaps) for the cheapest vendor, and get the item by giving your money in return.
Just like any market, a trader goes to the forex market to have an exchange of goods. The trader must have got satisfaction from the product he has at hand in exchange for what he gave. The exchanging of currencies at a specified price is what drives the forex market.
The forex market is a plethora of the biggest to the smallest of traders. Government banks, corporations, private banks, business entities, and retail traders are the ones engaged in the market of currencies. The bigger the trader, the higher the impact they make to the prices of paired currencies.
These big traders do not need intermediaries to enter the market of currency exchange. Instead, they have direct access to the Forex interbank. Meanwhile, private investors and retail traders go through brokers for them to enter the market so they will be subscribed to a leveraged trading account and gain access to the forex market.
Good knowledge of how the forex market works is a must-have to realize the nature of forex trading and spur the trading urge within you, only second to dispelling trade misconceptions and ignorance that impeded potential traders alike.