What is Forex trading and how does it work?

Forex trading or FX trading is the exchange of various currencies on a global market. Foreign currencies need to be exchanged in order to conduct international trade and business. It is also known as foreign exchange trading.

The Forex market is decentralized and one of the largest financial markets in the world. It is also the most liquid financial market. If you want to know how to start forex trading, you first need to know what the Forex Market is.

What is the forex market? 

Forex market is the place where currencies are traded. It is a global marketplace for the exchange of foreign currencies.

The Forex market is the most liquid market in the world  as it is open 24 hours a day and five days a week, from Sunday night to Friday night. It is the only non-stop and truly continuous financial market in the world.

Another unique aspect of the forex market is that there is no central marketplace for international exchange.  There are no physical buildings that serve as trading venues for the  Forex markets. Rather, forex trading is conducted electronically over the counter (OTC), via computer networks among forex traders around the world.

How Does Forex Trading Work?

In order to understand how does forex trading work, you first need to understand what is meant by a currency pair. 

Currency Pairs

Forex is always traded in pairs, known as currency pairs; for example, GBP/ USD (Sterling vs US Dollar). The combination of buying and selling currency is called a currency pair. 

A unique three-letter code is used to represent each currency in a currency pair. In that code, the first two letters identify the country and the third letter shows the currency, such as the code  USD means United States Dollar.

Forex trading is the process of simultaneous buying and selling of foreign currencies. The exchange rates between various currency pairs show the value of 1 currency in terms of another.  For example, rate in euro-dollar could be written as EUR/USD= 1.237

The first currency is known as the ‘base currency’ (in this example, the Euro) and the second currency is the ‘quote currency’ (in this example, the US dollar). Another example is JPY/GBP (Japanese yen/ British pound). Here, the base currency is JPY and the quote currency is GBP. 

When you trade forex, you buy one currency and sell another. If the currency you just bought goes up against the currency you sold, you get profit. 

You trade forex by speculating on whether the value of the base currency will rise or fall against the quote currency. So, in EUR/ USD, If you think that EUR will rise against USD, you buy the currency pair. On the contrary, if you think EUR will fall against USD, you sell the currency pairs. 

When Should you buy?

You should open a buy or long position if you believe after analyzing the trends that the value of a particular base currency will increase. 

When Should you Sell?

You should open a sell or short position if you believe that the value of a particular base currency will decrease.