The main purpose of the forex market is to make money, but it differs from other stock markets. There are various technical terminologies and strategies that a trader needs to know in order to deal with currency exchange. This article provides an insight into the normal workings of the forex market.
On the foreign exchange market, the traded commodity is the foreign currency. These foreign currencies are always valued in pairs. The value of a unit of a foreign currency is always expressed in another foreign currency. Thus, all trades involve buying and selling two foreign currencies at the same time. You only need to buy a currency if you expect the value of that currency to increase in the future. If it increases in value, you will need to buy the purchased currencies to get your profit. When you buy or sell a currency, the trade is referred to as an open trade or in an open position and can only be closed if you sell or buy an equivalent amount of currency.
You also need to understand how currencies are quoted in the forex market. They are always quoted in pairs as USD/JPY. The first currency is the base currency and the second is the quote currency. The market value depends on the currency conversion rates between the two currencies under consideration. Most of the time, the USD is used as the base currency, but sometimes the euro and pound sterling are also used.
The broker’s profit depends on the bid and ask price. The bid is the price the broker is willing to pay to buy the base currency for exchange of the quote currency. The ask is the price at which the broker is willing to sell the base currency in exchange for the quote currency. The difference between these two prices is called the spread, which determines the profit or loss of the trade.
Bid and ask prices are quoted in five digits. The spread is measured in pip, which is defined as the smallest price change based on the current conversion rates of the currencies under consideration. If the USD/JPY bid is 136.50 and the ask is 136.55, then the spread is 5 pips and you must recover the 5 pips of your profit.
Margin, used in Forex terminology, refers to the deposit that a trader puts into their account to cover any expected losses in the future. A high level of leverage is delivered by brokers to traders for currency exchange. The ratio is usually 100:1. The brokerage system calculates the funds required for the current trade and checks the availability of margin before executing a trade.
You must understand the characteristics of the forex market before investing your money. This market has extreme liquidity and is always alive, giving you widespread opportunities to make profits. Because there is so much potential for gains, there is also potential for big losses. You have to spend your time and effort and watch the market and act at the right time to make the profit.