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Forex Trading Basics
In Forex trading the products bought and sold are currencies, i.e. Money used in different countries and regions. The word "Forex" is short for "foreign exchange" which has to do with converting one currency into another, "foreign" currency, one used elsewhere.
In the worldwide Forex market, over 3 trillion dollars' worth of transactions is carried out every day, most of them by traders working to profit from the changes in relative values of currencies.
Trading Forex brings with an opportunity for making profits quickly since the values of currencies are constantly changing. There are many factors which affect a currency's value, but ultimately, as always, it's a matter of supply and demand.
Since the product traded on is currency, a Forex trader buys one currency while paying for it with another. The currency bought is called the "target currency" and the one used to pay with is known as the "base currency". In any Forex trade, two currencies that are involved referred to as the "currency pair". Since there are almost 200 different currencies in the world, there are, theoretically, thousands of different possible currency pairs. However, there are about 100 pairs as such, which are responsible for practically all of the volume of Global Forex trading, and out of these 100, there are pairs which are most commonly traded, such as the U.S dollar/Euro pair.
Most Popular Currencies in Forex Trading
As described above, there are many currencies traded in Forex markets the world over. But out of all these different currencies, there are several which are the most interesting to Forex traders. Among the currencies which are most commonly found in Forex trading currency pairs are the U.S dollar (USD), Euro (EU), British pound (GBP), Swiss franc (CHF), Chinese Yuan (CNY), Canadian dollar (CAD), Australian dollar (AUD), Japanese Yen (JPY) and several other currencies.
What Affects Currency Values
A certain currency's value is determined by many different factors. In generally speaking, the stronger a country's economy is, the better its currency will hold its value as compared to other currencies. Things like periods of local market depressions, wars, large scale natural disasters, unfavorable reports about the state of the economy etc. Will cause a currency's value to drop. It is important to understand that just like with any other product prices are determined by the balance between supply and demand, i.e. If many traders are selling U.S dollars and buying Euros the value of the U.S dollar will tend to drop and that of the Euro will rise.
How Profits are Made
Just like when trading on any financial product, profit is made by buying at a certain price and then selling at a higher one. In Forex trading, this means trading on a certain currency pair when the target currency is worth a certain amount in terms of the base currency (this is the "exchange rate") and then ending the trading position once the target currency's value has risen, i.e. The exchange rate had changed in our favor.
Pips and Spreads
Pips and spreads are two of the most basic terms a Forex trader must be familiar with.
A pip is the smallest figure in the number indicating the value of a certain currency. For instance, if the USD/EU exchange rate is 1.0563 then the "3" is the digit indicating pips. If the exchange rate then rises to 1.0567, there was a rise of 4 pips. In the case of the USD/EU example the value of each pip is one thousandth of a cent. The digit indicating pips for all currencies is the fourth after the decimal point, except with the Japanese yen, this currency's pip is the second digit after the decimal point.
The spread is the final difference, in pips, between the exchange rate the trade position was opened at and the exchange rate when the position is closed. For instance, if a trader gives an order to trade in Euros, buying them using U.S dollars, the currency pair is USD/EU, the exchange rate may be 1.0612 when the order to buy was given, and then 1.0635 when the Euros were sold back in U.S dollars. The spread therefore, in this case, was 23 pips in favor of the trader. If the trader had bought 10,000 Euros and then sold them, they would have made a 23$ profit. Trading fees in Forex are very low.