What is Forex Trading?

Forex trading, also known as foreign exchange trading, involves buying one currency while simultaneously selling another. Currencies are traded in pairs, and traders seek to profit from changes in exchange rates. The forex market is the world's largest financial market, operating 24 hours a day across major global financial centres.

The foreign exchange or forex market is a decentralised global market where traders can buy and sell currencies without physically meeting each other. This market determines the current or determined prices of currencies, enabling individuals to participate in the market through brokers like iFX.

Currencies are always traded in pairs, and the forex market sets the relative value of one currency against another. This facilitates international trade and investments and allows economic growth and development beyond national borders.

How Does Forex Trading Work?

Forex trading takes place through currency pairs such as EUR/USD, GBP/USD, and USD/ZAR. Traders speculate on whether one currency will strengthen or weaken against another. If the market moves in the trader's favour, a profit may be generated. If the market moves against the trader's position, a loss may occur.

Forex Terminology:

Essential Terms Every Trader Should Know

To navigate the world of forex trading, it is crucial to understand the core terms that form the foundation of this complex market. Here are the key concepts that every forex trader should be well-versed in:

b

Bid / Ask price

The bid price is the price a trader is willing to sell a currency pair.The ask price is the price a trader will buy a currency pair.These prices are displayed on the left-hand side of MT4/MT5 in the ‘Market Watch’ section.The difference between the bid and ask price is known as The Spread.
Bullish / Bearish

Market sentiment gives a view of the performance of a particular market or the stock market overall.When Market sentiment is Bullish, this means the price is going up.When Market sentiment is Bearish, this means the price is going down.An easy way to distinguish the difference is that bulls have horns and toss things in the air when provoked. Prices rising.When bears are provoked, they get on their hind legs and tear things down. Prices decreasing.

c

Currency Pair

There are 180 recognized currencies in circulation being used in 195 countries. As traders, we can speculate on the performance of a certain currency by using a range of analyses and research to determine how that currency will perform in the marketplace. How we trade these currencies is based on one currency’s performance against another – Forex Trading. When selecting a currency to trade, you will notice that these come in pairs. Let us use EUR/USD as a case study.If you were to ‘buy’ EUR against USD, you would be betting that the Euro is going to perform more strongly than the US Dollar.

Pairs are categorized into 3 core groups:

Major Pairs – The 8 common pairs all of which contain USD as the base currency or counter currency and one of the following – EUR, CAD, GBP, CHF, JPY, AUD, NZD.

Cross Pairs – These are any 2 major currencies which do not contain the US Dollar as the base or counter currency. These are deemed more volatile than Major Pairs. Examples include GBP/AUD, EUR/CAD, and NZD/CAD to name a few.

Exotics – These are lesser-known currencies which can be extremely volatile in the market. These include South African Rand, Hungarian Forint and Polish Zloty.

g

Going Long / Short

Going long or buying a currency means that you expect the price to rise. When a trader is going long on a currency pair, the first part of the pair is bought while the second is sold.

Going short is ‘selling’ one half of a currency pair in the hopes that the price will decrease.

When a trader is going short the first currency is sold while the second currency is bought.

l

Leverage

Leverage allows traders to control a larger trading position using a smaller amount of capital.
Lot Size

A Lot in Forex trading is the size of trade/position that you will open.1 Lot in standard Forex trading on a currency pair is the equivalent of 100,000 units of the base currency of the pair.If we look at EUR / USD, this means that opening a trade in USD would mean the trade size is $100,000.EUR being the base currency.1 standard PIP is worth $10This means a 10 PIP incremental movement in a buy trade, this would represent a $100 gain.

m

Margin

Margin is the amount of capital required to open and maintain a leveraged trading position.

p

PIP

A pip is the smallest standard price movement in a forex currency pair and is commonly used to measure profit, loss, and market movement.

s

Spread

The difference between the bid (buy) and offer (ask, sell) prices; in other words the spread is the commission that the brokerage house makes on each trade. This can vary widely between currencies and between brokerage firms. For example, USD/JPY may bid at 131.40 and ask at 131.45, this five-pip spread defines the trader’s cost, which can be recovered with a favorable currency move in the market.
Stop Loss Order

Order type whereby an open position is automatically liquidated at a specific price. Often used to minimize exposure to losses if the market moves against an investor’s position. As an example, if an investor is long USD at 156.27, they might wish to put in a stop loss order for 155.49, which would limit losses should the dollar depreciate, possibly below 155.49.

t

Take Profit

A target price set by a trader to automatically close a profitable position and lock in gains. It removes emotion from trading, ensuring profits are realised before market reversals.

Enhancing your knowledge of these essential forex terminologies will empower you to navigate the market with confidence. Remember to stay informed and continuously expand your understanding of the factors that influence currency price movements.

How the Market Works

The value of currencies in the foreign exchange market is influenced by various factors. Two main forces that drive changes in currency prices are supply and demand. When a currency's value increases, it means the demand for it exceeds its supply. Conversely, when a currency's value decreases, it means its supply surpasses its demand.

Capital Flows and Trade Flows

There are two key components that contribute to the movements in exchange rates: capital flows and trade flows. These factors are combined to form the balance of payments, which serves to quantify the demand and supply for a country’s currency over a specific period of time.

Trade Flows

Trade flows measure the net exports and imports of a country.

Countries with more exports than imports are likely to see their currency depreciate, as they need to sell their local currency to buy foreign currency for purchasing goods and services.
Conversely, countries with more imports than exports are likely to see their currency appreciate, as they need to sell foreign currency to buy their local currency for purchasing goods and services.

Interest Rate Theory

The Interest Rate Theory posits that interest rate differentials can neutralise the increase or decrease of one currency against another. This theory suggests that there are no opportunities to exploit differences in currency prices due to these interest rate differentials. Understanding the interplay of these factors, including capital flows, trade flows, PPP, and interest rates, is crucial for analysing and predicting currency movements in the foreign exchange market.

Capital Flows

Capital flows refer to the net quantity of currency traded through capital investments. It can be further divided into physical flows and portfolio investments.

Physical Flows: Physical flows occur when foreign entities sell their local currency to buy foreign currency for direct investments, such as joint ventures and acquisitions. An increase in foreign direct investment is seen as a positive indicator of economic health.
Portfolio Investments: Portfolio investments encompass investments made in global markets, including the forex market, stocks, and treasury bills.

Purchasing Power Parity (PPP)

The theory of Purchasing Power Parity suggests that exchange rates are determined by the relative prices of similar baskets of goods in different countries. According to this theory, the ratio of prices of a basket of goods in two countries should be similar to the exchange rate. However, this theory has limitations, as it assumes no trade-related costs and fails to consider other influential factors like interest rates.

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