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The Basics of Forex Trading You Need to Know

Adam Lienhard
The Basics of Forex Trading You Need to Know

Currency trading is also known as Forex trading or foreign exchange trading. It involves buying and selling currencies on the global foreign exchange market. It is the most extensive and the most liquid financial market globally. Traders participate in it aiming to profit from fluctuations in exchange rates.

Currency against currency

Currency trading is all about speculating on the relative value of one currency against another. 

Currencies are quoted in pairs, such as EURUSD (Euro/US Dollar), GBPJPY (British Pound/Japanese Yen), or USDCAD (US Dollar/Canadian Dollar). 

The first currency in the pair is known as the base currency, while the second currency is the quote currency. The exchange rate represents the value of the base currency in terms of the quote currency.

Majors and cross-currencies

In the foreign exchange market, major currencies are the most commonly traded currencies. These currencies are used as a reference for determining the value of other currencies in the market. They are highly liquid and include the following seven currencies:

  1. United States Dollar (USD)
  2. Euro (EUR)
  3. Japanese Yen (JPY)
  4. British Pound (GBP)
  5. Canadian Dollar (CAD)
  6. Australian Dollar (AUD)
  7. Swiss Franc (CHF)

Cross currencies, on the other hand, are currencies in which the United States Dollar (USD) is not the base currency in the currency pair. For instance, the base currency in a currency pair could be the Euro (EUR) and the secondary currency could be the Japanese Yen (JPY), which would result in the traded currency pair being EURJPY.

There are many available cross currencies in the Forex market, some examples of which include:

  1. Euro/Japanese Yen (EURJPY)
  2. British Pound/Japanese Yen (GBPJPY)
  3. Euro/Swiss Franc (EURCHF)
  4. United States Dollar/Japanese Yen (USDJPY)
  5. Australian Dollar/New Zealand Dollar (AUDNZD)
  6. Canadian Dollar/Japanese Yen (CADJPY)

Trading cross currencies is common and provides additional trading opportunities to benefit from currency price fluctuations.

When to trade on Forex?

Unlike other markets, currency trading occurs over-the-counter (OTC), meaning there is no centralized exchange. Instead, trading occurs electronically through a network of banks, financial institutions, brokers, and individual traders. 

The Forex market operates 24 hours a day, five days a week, providing traders worldwide with an opportunity to participate in the market at any time.

Why trade on Forex?

Traders engage in currency trading for various reasons, such as:

⚖️ It is best for speculation. Traders aim to profit from short-term price movements in currency pairs. They are buying low and selling high or selling high and buying back at a lower price.

🔐 It is good for hedging. Businesses and investors use currency trading to hedge against potential losses due to adverse exchange rate movements. By taking positions in the Forex market, they can offset the risk associated with currency fluctuations.

🌏 It is available for international trade. Currency trading facilitates international trade by allowing businesses to exchange one currency for another to conduct cross-border transactions.

💼 It is highly required for investment diversification. Currency trading provides an opportunity for investors to diversify their investment portfolios by including currencies as an asset class.

What trading strategy to use?

Forex trading involves the use of different trading strategies. You can rely on technical analysis as well as fundamental analysis. Here are some of the most common strategies used in currency trading:

Trend following. Use this strategy to identify and trade in the direction of the current market trend. Look for upward or downward trends and aim to enter trades that align with the trend. You may also use different trend indicators such as trend lines and Moving Averages to confirm trends.

Breakout trading. Look for significant price movements when a currency pair breaks through support or resistance levels. Monitor key levels and aim to enter trades after a breakout occurs, expecting the price to continue moving in the direction of the breakout.

Range trading. Range trading involves identifying currency pairs that are trading within a specific range between support and resistance levels. Aim to buy near support and sell near resistance, taking advantage of price oscillations within the range.

Swing trading. Swing trading is a medium-term trading strategy where traders aim to capture shorter-term price swings within a larger trend. You may hold positions for a few days to several weeks, taking advantage of price retracements or reversals.

Carry trading. Carry trading involves taking advantage of interest rate differentials between currencies. Traders aim to buy currencies with higher interest rates and sell currencies with lower interest rates, earning the interest rate differential as a profit. This strategy is often used in longer-term trades.

News trading. News trading involves trading based on the impact of economic or geopolitical news releases on currency prices. Analyze news events and their potential impact on the market and enter trades before or after the news release, depending on expectations.

Scalping. Scalping is a short-term trading strategy where you aim to make quick profits from small price movements. Scalpers typically enter and exit trades within minutes or seconds, relying on high liquidity and tight spreads.

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