What Is Forex Trading?
Forex trading also referred to as foreign exchange trading is basically the exchange of currencies used in different parts of the world. For example an American forex trader may decide to buy the Euro while simultaneously selling their US Dollars.
How Currency Trading Works
Usually, currency trading is done through a broker or a market maker. The forex trader picks a currency pair whose value they expect to change and places an order. Common currency pairs include EUR/USD and GBP/USD. The first currency in a currency pair is known as a base currency while the second is known as the counter/quote currency. A currency pair is often expressed in terms of the number of counter currency units required to purchase one base currency unit. For example if EUR/USD is 1.2545 then 1 Euro is worth US$1.2545.
Currency pairs often have a bid price and an ask price; the ask price is always higher than the bid price. The bid price in this case is the price that the broker is willing to buy at while the ask price is the price that they are willing to sell at. When a trader places an order with their broker the broker passes the order to an Interbank market partner. Later on when the forex trader decides to close their trade, it is the responsibility of the foreign exchange broker to close the trader’s position in the Interbank market and credit their account with the profit or loss from the transaction.
There are two main types of forex analysis used by brokers and forex traders to identify the most profitable currency pairs; technical and fundamental analysis. Technical analysis involves the analysis of price charts in a bid to identify technical patterns. For example, if the results of technical analysis show that the price of a currency pair will go down, several traders will act in response to their analyses causing the price to decline further.
The second type of forex analysis is fundamental analysis. This is where traders and brokers analyze all the macroeconomic factors that are likely to underpin the value of a currency in an economy. Such macroeconomic factors include GDP growth rates, interest rates, retail sales and unemployment rates. Both technical and fundamental analyses usually result in forex signals which are indicators that are used to predict the price movement of a currency pair. However, any forex signal must be supported by at least two indicators to warrant action.