When we talk about the Forex market we are actually talking about the foreign exchange market. It is therefore the currency market where currency pairs are traded against each other at exchange rates that constantly fluctuate depending on the volumes traded.
We will dedicate this article to the definition of the Forex market and how you can trade Forex.
What is Forex?
Forex is an over-the-counter market where participants trade currency pairs against each other p. ex. the euro against the dollar. Then, a profit is made on the difference in the exchange rate.
The most liquid market in the world
There are many agents in the money market. Including banks, countries, hedge funds, but also individuals. The popularity of Forex trading lies in the fact that it is the most liquid market in existence. Indeed, more than 5,000 billion US dollars are traded every day. The market is also open 5 days a week, 24 hours a day; enough to take advantage of opportunities at any time of the day.
When you start trading Forex you will come across words such as exchange rate or even pip. An exchange rate is the expression of the value of one currency in relation to another. Exchange rates are always expressed in pairs and can be floating or fixed. The pip is the unit of measurement used in the Forex market. This represents the fourth decimal place after the comma.
Why Trade Forex?
Forex trading can be used as a hedging strategy, but can also be used speculatively. The attractiveness of Forex trading comes from the fact that it attracts a lot of people thanks to its leverage effect. Indeed, leverage is a tool that allows you to increase your position or exposure to the market without having to use higher funds. In exchange for leverage, your broker will require collateral or coverage called margin. The latter is established by the broker, and is therefore different for each broker. In summary, this leverage effect allows you to significantly increase your earnings but can also cause you to lose more than the capital invested. Let’s see all this with an example:
A trader wishes to speculate in the Forex market and he has a trading account of €2,000. He does not wish to make use of the leverage effect and decides to intervene for €1,000 on the foreign exchange market. After a 1% appreciation of the Euro, the trader closes his position and makes only €10 profit. Which is not huge. In terms of 1% depreciation, the trader would have lost only €10.
Use of the ideal leverage effect
Thanks to the leverage effect, the trader could have increased his position without having to deposit additional funds. Let’s take the example with a leverage effect of 1/30. The €1,000 is used as collateral and the trader takes a position of €30,000. After a 1% appreciation of the Euro, the trader generates a profit of €300. That is 30 times more than without leverage. Of course, this is a double-edged sword. In the event of a depreciation of 1%, the trader also loses 300 on the €1,000 invested, which makes him a loss of 33%. So take the danger of the operation seriously. A depreciation of 5% generates a loss of €1,500 while the trader has only invested €1,000.
In conclusion, good risk management is essential when using leverage. Before you start, think about deepening your knowledge of money management. It is important to know how Forex works before getting started.