Background to Forex Trading
Forex trading refers to the trading in the foreign exchange market. It involves the trading of 2 currencies where you (the investor / speculator) are buying one currency and selling the other.
As an illustration, if you buy GBP/USD foreign exchange combination, you are Buying GBP and Selling USD. You would do this if you believe that Sterling (ie GBP) is going to strengthen relative to the United States Dollar (USD). If you did such a trade and Sterling did in fact strengthen relative to the Dollar, you could then do a reverse trade where you sell GBP/USD and lock in a profit since with the weaker dollar for the same number of sterling you will be able to buy back more dollars than you had originally sold, thereby making a profit.
Conversely if you sell GBP/USD, you are Selling GBP and Buying USD and would do that if you believe that sterling is going to weaken relative to the United States Dollar.
This is a similar to how it works when trading on the stock or commodity or any other trading market. You buy on the anticipation of prices increasing and sell on anticipation of their decreasing. Assuming your prediction turns out to be accurate you can reverse the original trade and lock in a profit at the difference between the opening and closing price. Similarly with forex you are buying or selling a pair of currencies with an associated exchange rate based on your expectation of how they will move in the future.
What Is An Exchange Rate?
The exchange rate reflects the purchasing power of one currency for another.
For example as of April 6th 2016 one pound sterling was worth about 1.40 dollars. A few weeks later on April 26th 2016 it was worth about 1.46 dollars. This meant that on April 6th if you paid one pound you would get 1.40 dollars, whilst on April 26th you would get 1.46 dollars. Pound sterling increased relative to the US Dollar by 6 cents in this time. In other words the purchasing power of pounds sterling increased relative to the US Dollar by 6 cents.
These currency pairs are traded on a global market where the exchange rate is determined by market forces. Forex is one of the most liquid markets in the world with many participants taking part from all over the world. The exchange rates fluctuate all the time based on supply and demand and market forces.
If there is an increase in supply for a particular currency or decrease in demand for it, its value will fall. Conversely if there is a decrease in supply for a currency or increase in demand for it, then one would expect its value to rise.
Benefits of Forex trading over other financial markets
There are many different currency pairs available to trade on the Forex markets. In fact any currency combination can be traded, subject to liquidity (ie there being enough buyers and sellers). Because you are both buying and selling when trading a currency pair (buying one currency and selling another) unlike the stock market where you lose if the market goes down, with Forex as long as you correctly anticipate future market moves you can make money. You are therefore not at the peril of a falling bear market. In other words Forex is recession proof.
In this respect, unlike the stock market where you can only sell stock you own, with Forex, if you believe a currency is likely to fall in value you can sell it, without limitation.
The Forex market operates 24 hours a day, 5 days a week, only closing on the weekend. So no worries about having to wait for the market to open in order to make an entry or exit a position.
Forex is such a liquid market that trading costs are very low, typically made up of the bid offer spread between buying and selling.
Due to the liquidity in the forex market, you are able to take advantage of attractive leverage (usually up to 200:1) which enables you to take advantage of very small movements in the market and still make sizeable profits. It should be noted that the offset of that is that you can suffer large losses if you do not control your risk correctly.