Currency Pairs Trading
Trading Instruments
Currency Pairs Trading
The Forex Trading Guide for Beginners
Currency Pairs Trading 101 — Everything You Need to Know
For the past few years (or even decades), the word “Forex” has been on everyone’s lips. Given that the foreign exchange market (or, Forex for short) is the largest financial market globally, that comes as no surprise. More and more traders are swarming it in the hopes of making money with good reason. The market has an enormous daily volume ($6.6 billion) and, because trading is possible at any hour during the workweek, it’s more liquid (active) than the stock or any other market.
How to Start
What is Currency Trading?
So, we know that there’s plenty of money to be made with Forex. But how does one do that? In other words, what actually is currency trading?
Currency trading is done with currency pairs. You sell one currency out of the pair and buy the other. In theory, you make money on the difference. Again, in theory, you can do that at any time, given that the Forex market operates 24/7.
However, although the Forex market is highly active, only a few currency pairs are responsible for a massive chunk of that activity. And, because these popular pairs aren’t equally active during all hours of the day and have their times of volatility and times when they are muted, most traders who deal with a specific currency pair will stay online and monitor the position of that pair at the same time.
However, although the Forex market is highly active, only a few currency pairs are responsible for a massive chunk of that activity. And, because these popular pairs aren’t equally active during all hours of the day and have their times of volatility and times when they are muted, most traders who deal with a specific currency pair will stay online and monitor the position of that pair at the same time.
That’s why currency pair trading has something we call trading sessions. The three most essential sessions are the US ( traders who deal with pairs based on the US dollar find the most volume in it), the European, and the Asian one.
How Does Forex Actually Work?
The Forex market works like any other, and the main goal is making a profit from trading. Essentially, traders exchange currencies — they buy one and sell another. Because there’s no central location to the Forex market, traders can do their magic 24 hours a day.
However, because no one can monitor market movements 24 hours a day, most traders focus on one of the trading sessions. They trade currencies against one another. As mentioned, that’s usually done in pairs. For example, the most common pair is the US dollar and the euro.
There are three different ways a trader can trade with foreign currency pair:
- On the spot
- Forward trade (not legally binding)
- Future trade (legally binding)
On the spot exchange is exactly as it sounds. The trader physically exchanges a currency pair either on the spot or within a very short period. On the other hand, forward and future trades happen a bit differently. Traders sign contracts to buy or sell currency, and they agree not only on the amount and the price but also on the time when this will happen. The difference between future and forward trade is whether the contract is legally binding.
Currency Pairs Trading
The Language of Currency
To be able to make money on the foreign currency exchange market, you have to know how it works. And, to learn that, you first have to get acquainted with specific terms.
When people talk about Forex, they often mention speculative Forex trading. Just like with any other trading, speculative trading of currencies means that you’re buying something at a specific price with the speculation that that price will go up in the future. So, there’s a tremendous amount of risk involved. However, there’s also a prospect of a big reward as well.
In Forex trading, traders speculate that the rate of the currency they’re buying at a specific time will appreciate. That means they can later sell it and make a profit.
When trading with currency pairs, one must know what the base currency is and the quote currency. The most common currency pairs are EUR/USD, USD/JPY, GBP/USD, etc. The first currency of the pair is the base currency, and that one gets compared in value with the second one (the quote currency). So, you value the base currency in comparison to the quote currency.
Main Terms in Currency Trading
Aside from these, there are also other terms that you should be aware of.
Currency Trading
Major, Minor, and Exotic Pairs
As mentioned, there are some common currency pairs that traders usually deal with:
- EUR/USD
- USD/CAD
- GBP/USD
- USD/CHF
- USD/JPY
- AUD/USD
- NZD/USD
As you can see, all of them include the US dollar. That’s because the dollar is the leading reserve currency.
These pairs have the highest liquidity (because more traders are trading them than other types of currency pairs), and the trading costs for them are lower. In fact, almost 90% of all trades involve the dollar.
Minor currency pairs don’t involve the dollar but focus on the Euro, Yen, or the British pound. These are:
- NZD/JPY
- EUR/GBP
- GBP/CAD
- EUR/AUD
- CHF/JPY
- GBP/JPY
Pairs and Pips
To be a trader on the Forex market, you have to trade with two currencies. A pip is the smallest possible increment of trade. You can trade one pip, but nothing smaller than that.
All currencies on the market are priced in the following format: X.XXXX (meaning, to the fourth decimal point). One pip (price interest point or percentage in point) is one-hundredth of one percent.
Lots
To be a trader on the Forex market, you have to trade with two currencies. A pip is the smallest possible increment of trade. You can trade one pip, but nothing smaller than that.
The standard lot represents 100.000 units of any currency, mini-lot corresponds to 10.000 units, while a micro-lot equals to 1.000 units.
Pairs and Pips
Leverage increases your standing while trading. It’s borrowed funds that you use to improve the potential return of an investment. With Forex trading, brokers are the ones who provide the funds, and they do so through margin trading.
Margin is the money you borrow to better your position for trading.
What Moves the Forex Market?
Central Banks
Supply and demand drive the Forex market, and the Central Banks control the supply. Their announcements, currency intervention, monetary policy, as well as exchange regime setting all push the prices of specific currencies up or down, which, of course, affects the trades.
Economic Data
Inflation rates and public debt, as well as their economic data such as manufacturing indexes, employment rates, and retail sales, give us an insight into how specific economy fares compared to others. So, based on that, we can predict how their currency rates will change.
If inflation rates go up, central banks might increase the interest rates of the currency, thus decreasing its value. The same goes for public debt. The higher it is, the lower the currency rates will be. Not to mention, public debt also increases inflation rates.
News Reports
Positive news about specific regions or countries can increase the demand for that region’s currency because they drive investments. If the demand for a particular currency goes up but the supply doesn’t follow, the price will go up.
Market Sentiment
Of course, news reports can only affect currencies if the market reacts to them. That’s the market sentiment. Traders anticipate there will be an increased demand (or supply) of a specific currency, and they act based on that assumption.
Credit Ratings
Of course, news reports can only affect currencies if the market reacts to them. That’s the market sentiment. Traders anticipate there will be an increased demand (or supply) of a specific currency, and they act based on that assumption.
Terms of Trade
Terms of trade is a specific term in trading that signifies the ratio between export and import prices. A price index of countries’ import and export prices can grossly affect their currency, which is, of course, valuable information for Forex traders.
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How Do Forex Traders Make Money With Currency Pairs Trading?
So, what does all this mean? Well, in practical terms, not counting for trade fees and stuff like leverage, here’s a plastic example. If you buy $100,000 (that’s your first trade) at the rate of 1.17660 and then wait until the dollar’s value increases to sell your $100,000 at the rate of 1.19745, you’ll have earned $2,085. How?
Well, easy. At the rate of 1.17660, you bought $100,000 for $117,660. Then, after the price increase, you have $119,450, which means the difference between the two ($2,085) is your profit.
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