Foreign exchange (Forex) trading or currency trading used to be something that people needed to do only when they were travelling to another country. They would go to a bank or a money changer and change some of their own local currency into the currency of the country they were visiting, at whatever exchange rate was offered. Today, when people talk about foreign exchange trading, they are generally referring to a type of investment. In 2016, trading on foreign exchange markets reached more than $5 trillion per day, as forex trading has become more popular.
What are Currency Markets?
It is commonly said that currency trading is a 24/5 market, but that is not entirely accurate. There are really three sessions – United States, Asian and European trading sessions. There is some overlap between these sessions, but during a particular session, the main currencies of that market will be traded. In other words, specific currency pairs will have the most volume during one specific session.
Understanding Currency Pairs
Currency trading is the selling of one currency and buying of another. Because of the way currency trading works, they are always quoted in pairs with the first currency listed (the base currency) being the one you’re buying and the second currency (the quote currency) being the one you’re selling. For example, if you’re trading GBP/USD, it means that you are buying British pounds and selling US dollars.
What is the Spread?
The spread is the difference between the buying price and the selling price quoted for a currency pair. You will always be quoted two prices – the buying price and the selling price. If you think the base price of a currency pair will strengthen, you buy the pair, which is known as opening a long position, or going long. If you think the base price will weaken, you sell the pair, which is known as opening a short position, or going short.
A pip is the smallest increment of a trade. It is generally a one-digit movement, commonly to the fourth decimal point. In our above example of a GBP/USD currency pair, if it moves from $1.35352 to $1.35362, it has moved one pip. In some cases, the quote currency is listed in smaller denominations and then one pip might be a movement in the second decimal place. A common example would be the Japanese yen, which might be listed as ¥172.139. Any decimal points listed after the pip are known as pipettes or fractional pips.
Why Currency Moves
Before you can begin to successfully trade in currency, you need to understand what moves currency. Like most other markets, the biggest factor in their movement, is supply and demand. However, there are other factors as well which need to be taken into account, including interest rates, geopolitical instability, economic data and more. It is important to understand how currency trading works, as well as the factors that leads to currency movements before you consider trading.