Forex trading is much like trading in a commodity market. While trading in this market, the traders buy and sell commodities like gold or oil in exchange for a currency. However, this is not exactly same when trading through forex which involves buying and selling of currencies. This means the value or one currency is determined relative to another.
Let’s take an example. Suppose a trader buys two barrels of oil for US Dollar 100. Like this, numerous other traders are buying and selling oil barrels, determining the price of one barrel. The payment is made in dollars which is another asset class. Hence, there are two asset classes involved in commodity trading.
But this is not the same with forex trading. This type of trading has one asset class i.e. currency. Suppose the current trading price of Euro/USD is 1.0863. A trader buys €50000 thinking that the price will go up. He must make the payment in USD. Same is the case with other currencies. I will explain this in detail in the later part of the chapter.
As the value of Euro can be determined in different currencies such as Yen, Francs, USD, etc, it is impossible to finalize an absolute value in the forex market. But in the commodity market, global trading is done only in one currency i.e. USD, so it becomes possible to determine an absolute value.
Forex trading can be done 24 x 7. To trade in currencies, you have to select a broker and open an account. Trading can be done online or using the broker’s software. After logging in you will encounter a term “Forex Price Quote.” This quote is basically a record of the last transaction done by the two financial actors.
A quote typically looks like this:
EUR/GBP 0.8498 (An example)
There could be
any currency/any currency (value)
The above example quote shows that the trading is done between Euros and GBP. The currency on the left side i.e. EUR is the currency available for purchase whereas the one on the right side i.e. GBP is the currency to make the payment in. The variable value i.e. 0.8498 is the value of GBP in 1 EUR which means to buy 1 Euro you have to pay 0.8498 British Pound.
In forex trading, buying a currency is called long, and selling is called short. In the case above, you bought EUR (Long) and Sold GBP (Short) to open a position. Any trading market works on the same principle: Buy cheap and sell expensive. So after you long the EUR, you wait for its value to increase, for instance from 0.8498 to 0.8508 so that you can finally close the open position which is done by selling the EUR and buying back GBP putting the profit in the pocket. Although you traded Euros, your base currency was GBP, so your profit will be measured in GBP.
Let us end this chapter with an example:
The current price of GBP in 1 AUD is 0.5919 which would be shown in your trading software as AUD/GBP 0.5919.
You open the position by buying 100 AUD for 59.19 GBP (100 AUD x 0.5919) and then wait to increase the price to 0.6919 (for example. It depends on you how much you want to wait which is finally determined by the knowledge and practice). Now, once the desired price is touched, you close the position by selling 100 AUD for 69.19 GBP (100 AUD x 0.6919) and bag the profit of 10 GBP as the initial price at which you bought it was 59.19 GBP. Looks easy; demands experience.
Now, you have learned about the quote, let’s head on to our next chapter that will teach you the terminology in the forex market.