How does the Forex market work?

 How does the Forex market work?

[Forex] What is the currency market and how does Forex work?
[Forex] What is the currency market and how does Forex work?

[Forex] What is the currency market and how does Forex work?

 How does Forex work? This is a question that everyone who wants to start trading in the currency markets should ask themselves. Unrealistic goals, greed, inappropriate haste, and insufficient knowledge are the main reasons for the failure of those who attempt to start a career in trading. If you want to become a successful trader, let's understand how the Forex market works together.

Basics of Forex: Supply and Demand

 In economics, supply and demand is a model that explains pricing in a free competitive market. The price of a product is determined at the point where the quantity of the product desired by consumers balances with the quantity of the product offered by producers.

 Let's say you went to a store to buy apples. There are two sellers, and both have the desired quantity of apples you need. This means that the supply of apples exceeds the demand. Competition between the sellers will lead to a decrease in apple prices because both sellers understand that you will likely buy cheaper apples under equal conditions. Conversely, if the demand for apples exceeds the supply, the seller will increase the price of their apples, confident that they will still be purchased.

 This law applies to the Forex market as well: every time a specific currency is bought, it creates an excess demand in the market, pushing the price out of equilibrium and driving it up. Similarly, every time a specific currency is sold, it creates an excess supply, again pushing the price out of equilibrium and driving it down.

 The constantly changing supply and demand for currencies is what causes fluctuations in Forex charts.

What is Forex? 

 Forex (short for Foreign Exchange) is an international over-the-counter currency market where market participants trade (buy and sell) currency pairs.

 Forex is the largest market in terms of capitalization in the world, so it's not surprising that a huge number of participants are active in it daily.

Who are the participants in the Forex market?

The largest participants in the market are multibillion-dollar national banks, multinational corporations, and hedge funds. Their monetary and credit policies, as well as their trading decisions, create the biggest waves and have the most impact on pushing prices out of equilibrium. There are medium-sized companies, such as private investors and companies in need of hedging, as well as private banks. Then there are smaller players, such as financial brokers, smaller banks, and individual investors.

Most of the aforementioned market participants have direct access to the interbank Forex market, which is where all currency exchange operations take place. They have this access simply because they have funds that exceed a certain threshold. Thus, they can trade with each other without intermediaries.

The smallest players become retail Forex traders, which includes you as well. The purchasing power of an average trader is usually so small compared to higher-level traders that they need a Forex broker or a bank that provides a trading account, financial leverage, and access to the market through trading servers. Understanding how the Forex market works, as well as your position in it, gives you a great understanding of why it's important to exercise necessary caution when trading.

How Forex Works: Key Terms and Concepts

The value of a currency is measured by how much of another currency can be bought with one unit of it. This is called a price quote. The quote always consists of two prices:

  • Bid price (the price at which buyers are willing to purchase)
  • Ask price (the price at which sellers are willing to sell)

 You buy currency at the ask price and sell it at the bid price.

 Note that the asking price of any financial instrument is always higher than the bid price. Therefore, a bank will always buy your currency at a slightly lower price and sell it to you at a higher rate.

 Bid and ask prices are available to market participants at all times, except when the market is closed. Traders receive quotes via the Internet from the broker who provided them with a trading account. In turn, the brokerage firm receives price quotes from its liquidity providers, i.e., banks.

 The spread is the difference between the bid and ask prices and serves as the broker's commission that you pay for their services.

 In general, the more liquid the market, the smaller the spread. Trading on Forex usually does not pose any problems, and liquidity is more than sufficient. However, there are instances, such as during the release of important news, where price gaps (price discrepancies) occur due to significant price changes within a very short period.

How does Forex trading work?

 These days, almost all services have transitioned to an online format, including trading. Currency trading takes place on a trading platform chosen by the trader. Currencies are always traded in pairs, and the movement of currency pairs measures the value of one currency relative to another.

 For example, the EUR/USD currency pair measures the value of the euro relative to the US dollar:

  • When the value of this pair increases, it means that the value of the euro has increased compared to the value of the US dollar.
  • When the value of the pair decreases, it means that the value of the euro has decreased compared to the value of the US dollar.
  •  When an order to buy the EUR/USD currency pair is placed, a portion of the trader's funds is used to buy the base currency of the pair (in this case, the euro) and sell the quote currency (US dollars).
  • The order is either placed within the broker's system (market maker) or directly routed to the interbank Forex market (ECN execution), where major players operate.
  • Next, depending on the trading strategy, the trader waits for the purchased currency to increase in price relative to the sold currency. When the trader is satisfied with the profit, they close the order, and the broker performs the opposite action, i.e., sells euros and buys dollars. The opposite process occurs when a trader places a sell order.

 The concepts of buying and selling in Forex can be confusing at first because, in each transaction, one currency is exchanged for another, meaning that each transaction is both a "buy" and a "sell" of currency.

 Nothing prepares you better for Forex trading than a demo account. You can open a free demo trading account with Admirals, test the trading platform, and practice your ideas and strategies in a virtual trading environment without risking your funds.

Trading Platform for Forex:

 A trading platform (trading terminal) is software that traders use to engage in trading activities.

 To start trading in Forex, you need to open an account with a reliable broker and download a platform that provides access to the markets as an application or program on your computer. Everything you need to execute trades is already available within the platform.

 If you want to start trading in the Forex market and thousands of other markets, the MetaTrader 5 platform is considered one of the best for these purposes. It can be used as:

  • A desktop program.
  • A mobile application to trade from anywhere in the world.
  • A web terminal to trade directly from a browser without installation.

 Traders can execute buy and sell trades, track the movement of currency pair prices, and a wide range of other financial assets, such as CFDs on stocks, commodities, stock indices, etc. The platform also provides access to market news, allows various charting options, and enables the use of different indicators for technical analysis.

 In addition, there is also the MetaTrader 5 Supreme Edition (MT5SE) platform, which is a plugin for MetaTrader developed by Admirals. With it, you gain access to over 60 additional features not available in the standard platform. Admirals clients can download MetaTrader 5 and the Supreme Edition plugin completely free of charge.

How to trade Forex using leverage?

Leverage is essentially a tool that allows traders to increase their trading opportunities in their Forex account. With leverage, traders can enter trades with volumes several times larger than the capital they have.

For example:

A trader wants to buy one lot of EUR/USD, which has a value of 100,000 euros. To open the position, the trader would need to have 100,000 euros. However, the broker provides the trader with the opportunity to use leverage of 1:500. In this case, the required amount of funds for the trader would be:

  • Position Size / Leverage = 100,000 / 500 = 200 euros (instead of 100,000)
  • Using leverage can increase a trader's profits. However, leverage is a double-edged sword as it can equally increase potential losses.
  • You can find more information about how leverage works in Forex trading in our article "What is Leverage in Forex Trading?".

Using Trading Signals in the Forex Market:

 Forex trading signals are recommendations that alert traders to the best times to open or close a trade.

 Trading signals can be used in all markets, including stocks, commodities indices, and Forex. However, Forex signals are undoubtedly the most common. Typically, these signals are generated by either a trading algorithm or a trader performing technical analysis.

Real-time Forex signals often include the following information:

  • Currency pair
  • Opening trade price
  • Stop-loss price
  • Exit trade price
  • Instructions to buy or sell at a specific time.

 Traders can receive these signals through email notifications, text messages, or messaging apps. More recently, traders also have the option to subscribe to a signal provider, and their trades will be automatically replicated in their trading accounts. This is particularly convenient for novice traders or those who lack time for independent trading. This service is called copy trading.

Using Trading Robots in Forex:

 Using automated trading systems requires extensive research to find the right software that you can trust to execute trades. The prospect of relaxing and letting an automated trading system do all the work for you may seem enticing. This is where trading bots come into play.

 A trading robot is a computer program based on a set of trading signals that helps determine whether to buy or sell a specific currency pair at a particular moment in time.

 While it may seem like an easy way to trade and make profits without much effort on your part, robots are not always reliable.

How to Start Trading Forex?

Now that you understand how the Forex market works, the most important question remains: how to start trading Forex. You can begin trading on the currency market in just a few steps:

  1. Choose a reliable broker.
  2. Open a trading account with them and make a minimum deposit.
  3. Download a trading platform.
  4. Make your first trade!

 Many people believe that $100 is too small of an amount today. However, if you decide to trade Forex, $100 is enough to get started. You can even make money in Forex without any initial investment.

 Over time, with the right trading strategy and risk management, trading can become a new source of income for you.

 If you are a beginner in trading, you can start by limiting your trading activity to one currency pair before opening positions on multiple pairs in your account. Each currency pair has its characteristics, so the trading approach for each of them will differ.

 One of the best pairs for beginner traders is the EURUSD pair. This is due to its high liquidity and narrow spreads. These are some of the reasons why this currency pair is the most traded in the market.

 It is worth noting that a lack of education is the reason why many novice Forex traders fail before they can understand how Forex works.

 That's why Admirals provides access to an extensive library of educational materials on everything related to trading and investing. 

 If you're ready to start trading Forex, the Admirals demo account is the perfect place for you! Trade currency pairs and CFDs (Contracts for Difference) on thousands of trading instruments, use access to technical analysis tools and the latest market news. Open an account for free by clicking on the banner below.

Popular Questions About Forex Trading:

What is Forex in simple terms for beginners?

 In simple terms, Forex is a market where participants (traders) buy and sell various currencies. It's like currency exchange at a bank but with much greater possibilities. The trading volumes in Forex are immense, and the currency market is not tied to a specific location or exchange.

How can you make money in Forex?

 You can make money in Forex by speculating on currency prices: you buy a currency cheaper and then sell it at a higher price, or you sell a currency at a higher price and then buy it back cheaper.

What is the essence of trading Forex?

The essence of Forex trading is buying and selling currencies. Market participants profit from changes in currency rates (price increases or decreases) when trading currency pairs.


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