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What is Forex Trading? (FX): How Does It Work?

What is Forex Trading? (FX): How Does It Work?

Forex Trading is a buzzword that nearly everyone is talking about today. But what does it mean, and how does it work? These pressing questions make sense, especially if you want to explore Forex trading and earn from it.

Otherwise, you risk getting involved in something you don’t understand, and the consequences can ruin your finances.

So, what is forex trading, and how does it work? Here is a complete guide to get you started.

What is Forex Trading?

These currencies are exchanged in the forex market, which is usually open 24/5, save for weekends. This time limit is due to the time zone overlap of four financial centers, Sydney, Tokyo, London, and New York. And since it can be accessed electronically via a network of banks, it is also known as an over-the-counter market. 

Banks, investment firms, and hedge funds are some of the biggest contributors and participants in forex trading. While they don’t usually intend to buy the currencies themselves, they speculate about or hedge against future exchange rate fluctuations.

How Does Forex Trading Work?

So, how does Forex trading work? Well, a lot goes into Forex trading, and if you want to understand how it works, you must familiarize yourself with a few issues. A perfect starting point is to understand the forex trading currencies, which are always traded in pairs.

These currencies are assigned a three-letter code, much like a stock’s ticker symbol. Below are the most popular forex trading currencies and their three-letter codes: 

  • US Dollar (USD)
  • Euro (EUR)
  • Japanese Yen (JPY)
  • British Pound (GBP)
  • Australian Dollar (AUD)
  • The Canadian Dollar (CAD)
  • Swiss Franc (CHF)
  • New Zealand Dollar (NZD)

When it comes to the actual trade, for instance, in the case of a EUR/USD currency pair, a trader will sell one currency (EUR) and buys another (USD). The currency on the left (the Euro) is the base currency, while the one on the right (the US dollar) is the quote currency. Below are the prominent forex pairs.

  • NZD/USD 

The exchange rate will tell you how much of the quoted currency you need to buy one unit of the base currency. For this reason, the base currency is always expressed as one unit, while the quote currency varies based on the market.

So, for the EUR/USD pair with an exchange rate of 1.2, you need 1 EUR to buy 1.2 USD. As the exchange rate rises, the base currency increases in value, giving you better chances to buy more USD with 1 EUR.

What Does It Mean When a Forex Trader Buys or Sells a Forex Currency Pair?

When you buy a currency pair, you predict the price to rise. Ideally, the base currency will strengthen compared to the quote currency. But when selling a currency pair, you anticipate the price to fall, weakening the base currency against the quote currency.

So, a forex trader would buy the EUR/USD pair if they believe the Euro would increase in value compared to the USD. And an increase in Euro value will give the trader more USD to buy 1 unit of Euro.

Alternatively, you would sell the EUR/USD pair if you predict the price of the EUR to weaken against the dollar. Such a move will make you spend a few dollars to buy 1 Euro.

Conclusion: Should you Try Forex Trading?

The forex market is among the world’s largest and most liquid financial markets. Therefore, it is a must-try if you wish to trade currencies without worrying about liquidity issues.

But to maximize your investment, you must learn and stay updated on political, economic, and geographical events. Such events will influence market prices, and your decision to buy or sell a currency pair will rely on them exclusively. You must also understand the currency pairing for a successful trade.

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