Basic Principles of Forex Trading

The first thing to understand is that forex market is a global market created by banks, market makers and brokerage houses where trading in currencies takes place 24 hours a day and 7 days a week. The market is open to all and has the potential to give huge profits. It is also the biggest financial market in the world where trillions of dollars are traded during the course of a day. At the same time forex trading is a growing market as more traders are turning away from trading in stocks.

Trading in forex involves trading simultaneously in two currencies, which is known as a pair. When you are selecting a pair you are trading one currency against the other. The first name in the pair (base currency) is the currency you are buying and the second name (counter currency) is the currency you are selling. For example, if you choose EUR/USD you are buying the Euro against the US Dollar.

Similarly, there is a fixed format of displaying prices. The price is always of the counter currency. If the price of EUR/USD pair is shown as 1.3667 that means one Euro is trading at 1.3667 dollars.

Most prices are displayed in 4 decimal points with the exception of the Japanese Yen, whose price is displayed in 2 decimal points. The reason behind this is that the Japanese Yen is usually more than 100 Yen to the dollar. Thus, if the USD/JPY price is expressed as 108.25 it means that the Japanese Yen is trading at 108.25 to the dollar.

The minimum change that can occur in the price of a pair is called pips. It is the fourth decimal point expressed in the pair price. For example, if the price of EUR/USD changes from 1.3667 to 1.3668 it is said to have risen by one pip. This is what makes your profits run and rise instantly in forex trading.

The bid price of a pair is always listed first and the ask price is listed second. Now, what is a bid price and what is an ask price. The bid price is the price that the market is ready to buy from a seller at a given point of time. The ask price is the opposite of a bid price and is the price at which the market is willing to sell a specific pair. For example, when the price of EUR/USD is quoted as 1.3667//1.3670, the first is the bid price and the second is the ask price. The difference between the two is known as spread, which in this case is a spread of 3 pips.

Trading in equity and stocks involves commissions that a client pays to a brokerage house for trading. In the forex market the market makers and brokers earn through the concept of spread. The spread of a currency pair largely depends upon certain factors. These include but are not limited to market conditions, specific broker or market maker and the currency pair you are trading in. The currencies where trading turnover is low have a higher spread while the frequently traded currencies have extremely low spreads. Also, some brokers/market makers are known to charge more than others.

Forex trading is done in “Lots.” A LOT means the units of the base currency that you are trading in. Lots are normally termed as standard, mini and micro lots. A standard lot comprises of 100,000 units, a mini lot of 10,000 units and a micro lot of 1,000 units of a currency pair. If the EUR/USD paid is quoting at 1.3667/1.3670 and you are buying a standard lot then that means you are buying 100,000 Euros and selling short 136,700 dollars.

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