Forex, what it is and how currency trading works

Forex trading, or foreign exchange trading, is one of the largest and most dynamic financial markets in the world. Every day, billions of dollars are exchanged between banks, institutions, governments, companies and private traders. But what exactly is Forex, and why does it attract so much interest?

In our in-depth guide, we will discover what Forex is and how it works, how it is regulated and how it is really (and concretely) possible to profit and from online currency exchange.

Before going into detail, however, you should know that Online Trading on Forex involves risks and technical difficulties. Making money with Forex is certainly possible but far from easy and to understand how it works, you can use a demo trading account to see for yourself what it is. For the rest, here is everything you need to know about Forex.

What is Forex? Here’s what it means

The term "Forex" comes from the English foreign exchange and refers to the largest and most liquid financial market in the world, where currencies are traded against each other. For example, you could trade euros for US dollars or Japanese yen for British pounds.

The mechanism behind forex trading is very simple: we are talking about the simultaneous buying and selling of currencies. You buy one currency and simultaneously sell another. Currencies are always traded in pairs - for example the euro and the US dollar (EUR/USD) - and the exchange takes place through a broker or dealer.

Forex is essential to international trade, as it allows companies to buy and sell goods in different currencies, but it has also become one of the most popular speculative activities among traders. In fact, until a few years ago, before the explosion of the phenomenon of online trading, Forex trading was the exclusive domain of large financial institutions. The mass diffusion of the internet has revolutionized this market, and now even small investors can buy and sell currencies with just a click, through online brokerage accounts offered by specialized brokers.

What sets Forex apart from other financial markets is its decentralized nature: there is no central exchange, like the NYSE for stocks. Currency trading takes place over-the-counter (OTC), which means that all transactions take place via computer networks located around the world, 24 hours a day. This flexible time allows traders to trade at any time, making it particularly attractive to those looking for investment opportunities outside of traditional working hours.

Forex is known for its high liquidity and the use of leverage, which allows you to move large amounts of money with a relatively small initial investment. However, this can also amplify the risks, which is why it is crucial to fully understand the mechanisms of the market before starting.

Whether you are a beginner or an experienced trader, Forex offers endless opportunities, but it requires discipline, strategy and a solid knowledge of economic fundamentals to be successful. When exploring this fascinating market, the key is to combine theoretical learning with practice to develop a sustainable strategy.

Is Forex suitable for small investors?

"Okay, I understand what Forex is and I know that currencies are bought and sold, that there are Forex brokers. But is this market suitable for me? Do I have enough capital to invest in the largest financial market in the world?"

Forex trading is suited to the needs of small investors through leverage, which however should not be abused.

The daily fluctuation in the value of currencies is usually very small. Most currency pairs move less than a cent per day, a change of less than 1% of the value of the currency itself. Therefore, many traders rely on leverage to increase the value of the trade.

The high liquidity and the ability to use leverage have helped spur the rapid growth of the Forex market, which has become a perfect market for small investors.

How does the Forex market work?

Forex is a decentralized market where prices can vary from one dealer to another. There is no governing body in this market and each intermediary offers a quote strictly based on the current market value.

Let’s make everything simpler and take a practical example to understand how Forex works.

We are faced with this exchange rate of the euro against the dollar:

EUR/USD = 1.03

What does this mean?

• The first currency in the denominator, in our case EUR (euro), is called the base currency.
• the currency in the denominator, in our case USD (US dollar), is the quoted currency (also called secondary).

In other words:

• if you want to buy, the exchange rate (1.03) will tell you how much you have to pay in terms of the quoted currency (USD) to buy one unit of the base currency (EUR). So, based on our example, you will have to pay 1.03 US dollars to buy 1 euro;
• if you want to sell, instead, the exchange rate will tell you how many units of the quoted currency (USD) you receive by selling one unit of the base currency (EUR). In simpler words, by selling 1 euro you will receive 1.03 US dollars.

The advantages of Forex trading

"Why do many people talk about investing in Forex?"

Why should you choose Forex for online trading?
Here are 5 initial advantages that only Forex can give you:

1. no commission: most brokers cover the costs of the service thanks to the spread between the bid and ask;
2. initial capital (or access) minimum: each investor determines the size of his position by himself. Thus, you can buy and sell currencies starting from a small investment of a few hundred euros;
3. 24-hour market: The forex market is open 24 hours a day, five and a half days a week, and currencies are traded around the world in the major financial centers of London, New York, Tokyo, Zurich, Frankfurt, Hong Kong, Singapore, Paris, and Sydney - spanning nearly all time zones;
4. leverage: With leverage, forex trading allows you to control contracts with very high values;
5. high liquidity: Forex trading is an extremely liquid market. Each order is therefore placed instantly on the market because there will always be someone willing to make the trade with you.

Online trading on Forex has many advantages, but just as many risks. It is important to remember that it is a market created by specialists and the possibility of using leverage must be weighed against the risk appetite, since it allows you to obtain profits (or losses) greater than what you have invested.

How to make money with Forex?

Finally we have arrived at the most exciting part: how to make money with Forex?

Placing an order in the Forex market is very simple, many dealers offer a very simple and intuitive interface.

Let’s take another example:

• you decide to buy 1,000 euros of EUR/USD at an exchange rate of 1.0300. Your balance will automatically be +1,000 euros/-1,030 dollars;
• after some time the exchange rate changes and reaches 1.0500;
• you decide to exchange the 1,000 euros purchased, so you want to sell them, and your balance will be -1,000 euros/+1,050 dollars.

Summarizing the results obtained for both the euro and the dollar, we will have:

EUR +1,000 – 1,000 = 0
USD -1,030 + 1,050 = +20

The profit of this operation was, therefore, 20 US dollars!

Long and short: what does it mean?

Even within the Forex market, as in the stock market, we talk about long position (or long) and short position (or short).

In Forex, these terms take on a particular meaning that you absolutely must know:

• if you buy the base currency and sell the quoted currency, it means that you expect the base currency to increase in value so that you can then resell it at a higher price. In Forex trading language, it is called “going long” (long);
• if you sell the base currency and buy the quoted currency, it means that you expect the base currency to decrease in value so that you can buy it back at a lower price. In Forex trading language, it is called “going short” (short).

This explanation is taken from , where you can learn and perfect your skills in online trading on the financial markets.
Attend the courses, take the exams and earn all the available belts!

Bid price and Ask price: what are they?

All currency pairs in Forex are quoted with two prices: the Bid price, or selling price, and the Ask price, or buying price. The selling price is always lower than the buying price. The difference between the two prices is called the “spread” and represents the broker’s margin.

You may also be interested in Forex: the currency market summarized in 10 points and our entire Guide for aspiring traders.

Forex: the main trading strategies

Now it’s time to refine your training. It’s not enough to know how Forex works, things are much more complex and for this reason it is always advisable to find the right trading strategy that perfectly suits your objectives and investment margins.

The Forex market lends itself to different approaches in terms of trading strategies that can vary depending on the exchange rate on which you operate and the market phase as well as the preferences and style of each trader.

Here, among others, are the main trading strategies.

• Price Action: Price Action is a technique based on the identification of technical figures and the placement of orders in relation to the presumed trend of prices upon completion of each figure. Price Action is therefore based on the systematic analysis of charts on multiple timeframes and on the application of the main theories of technical analysis on continuation and reversal figures.
• Trading on supports and resistances: is a strategy based on the frequent explosions of volatility that are created when the levels of support or resistance are violated. It allows a good risk/reward ratio and the definition of precise entry and exit levels.
• Scalping: scalping is a trading style made up of frequent orders with very high volumes placed on the market with the aim of "capturing" small profits for each trade. Those who use this trading technique should choose brokers with very low spreads and very liquid currency pairs.
• Trading on the News: this technique, very risky and therefore potentially very profitable, consists of taking a position by "betting" on the trend of an exchange rate after the release of important economic data or in correspondence with the official statements of central banks on rates and monetary policies. The release of this data is predictable thanks to the economic calendar.
• Trading Trend Following: this trading style is based on strategies implemented over medium-long time periods. A long-term trend is identified and positions are opened in the same direction, waiting for the continuation of the trend to bring profits. The defects of this approach lie in the possible entry errors on lateral phases or on the inversion or on strong corrections of the primary trend, not infrequent phenomena that could trigger stop losses (literally ‘stop losses’) in series.

Forex Brokers

Over the last 15 years, more and more private traders have started trading on the Forex market thanks to the growing availability of brokers and platforms, in addition to the number and increasingly high quality of complete and timely information on the currency markets also in Italian thanks to sites such as Money.it.

The private trader who wants to invest in the Forex market must turn to a Forex Broker, i.e. a company that provides its customers with a trading platform and the possibility of using it to position themselves in selling and buying on one or more currency pairs.

Most brokers offer the possibility of trying their platform for free to do simulated trading (demo), an uncommon opportunity of access compared to various other markets that often require fixed fees for the license of the platform in order to operate.

Trading on Forex can also be done through Cfd (Contracts For Difference): in this way it is possible to trade on the same platform also on stocks, indices and raw materials without the costs of a securities account at a bank and with the possibility of using even high financial leverage (a double-edged sword, it is always good to remember).

How to be successful with Forex?

Knowing some notions is not enough to be successful in Forex. Of course, there is no single formula for trading successfully. Trading aptitude is a necessary factor. Combining good analysis with a good attitude will greatly improve your success rate and, as with many other things in the world, success in trading comes from a combination of talent and hard work.

Below are some pillars on which to base your rise to success in Forex but also all other financial markets.

1- The right approach

Before you begin, recognize the value of adequate preparation. The first step is to align your personal goals and your predisposition with the instruments and markets in which you feel most comfortable. For example, if news comes out that affects retail, try to use the information to trade retail stocks, rather than oil futures, for which perhaps at that moment you do not have supporting information to operate in one way or another.

This analysis allows you to make the right choice in relation to:

• timeframe;
• strategy;
• type of market.

2- The right attitude

Attitude in trading means making sure that your mind can always respect the principles of:

• patience;
• discipline;
• objectivity;
• realistic expectations.

3- The right management

You should never invest haphazardly. Always develop a risk management strategy so that you lose less than you can afford. Always calculate the potential losses you could face and develop a strategy that protects you even just partially from this risk.

The trick in Forex is to take one step at a time. The Internet is full of information about Forex, our site is full of very useful resources and they are completely free. Read, study, try investing with a free demo and take your time before trying with real money.

Original article published on Money.it. Original title: Forex, cos’è e come funziona il trading sulle valute