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What is the Forex Market?
“Forex” stands for Foreign Exchange and refers to buying and selling of one currency in exchange for another currency.
Forex Trading is an extremely popular and heavily traded market in the world because everyone right from common people to business to huge industries likes to take part in this trading as it is an easy market to jump in and doesn’t require much capital.
Forex is the largest and most liquid asset market in the world because of its high volatility and ever-increasing or decreasing currency values.
Let’s say Peter goes on a trip to London and he converts his Indian currency to Pounds (GBP). By exchanging his home currency for foreign currency, he participated in the Forex market.
Yes, that’s how simple the meaning of Forex is!
But wait, understanding when to invest your money in forex is not simple, it’s rather quite complicated.
So let’s break it down to understand it much better so that we can start investing and taking advantage of the Forex market right away.
What is Currency pairs primer?
Forex is always traded on pairs of two, meaning when you exchange one currency for the value of the other, it is called a currency pair.
Currency pair primer shows you the value of one currency relative to the other. Peter exchanged his Indian currency(INR) into Pounds (GBP), what this lets us know is how many Indian rupees(INR) it takes to buy one pound(GBP).
This is how we get the value of each currency in comparison with the other.
The forex trading market uses special Notations to designate specific currency pairs. The notation for Indian Rupees is INR, similarly, for British Pounds it is GBP
Other common widely used notations are
|Country Name||Currency Code|
|United States Dollar||USD|
Each forex pair has a Market price which indicates how much of the second currency it takes for you to buy the first currency.
Confused? Here’s an example
Let’s take currency pair GBP/INR as our example.
The market price of our currency pair is 92.43 (currency rate fluctuates constantly, at the time you read this the rate can be different), which means it takes 92.43 rupees to buy one Pound(GBP).
Sage Tip: If you want to use an easy math trick to find the value of INR/GBP, the opposite of the value above, simply divide 1 by 92.43 and you will get 0.0107 which is the exact value of the currency pair INR/GBP.
Another term you’ve got to learn is “Pip”. It stands for Point In Percentage and is used to indicate the fourth decimal place in the value of the currency pair or the second decimal place when JYP (Japanese Yen) is used.
Forex is traded in specific amounts called lots. It basically means the number of units you will sell or buy at a point in time.
There are four types of lots for purchasing currency:
1. Nano lot – 100 units
2. Micro lot – 1000 units
3. Mini lot – 10000 units
4. Standard lot – 100000 units
Major currencies move 50 to 100 pips a day (it can move more or less depending on market conditions).
If the price of GBP/INR increases from 92.4317 to 92.4367, it is an increase of 50 pips. If you bought a pair at 92.4317 and sold it at 92.4367, you just made a profit of 50 pip. Hurrah!
The currency value of one pip in GBP/INR is 0.0025. Pip value differs from pair to pair. Wherever the INR has been listed in second place, the above pip value stands correct i.e (GBP/INR) INR has been placed second.
So let’s say you buy a mini lot,
10000 units (X) 0.0025 = Rs 25
Thus the profit you made on the mini lot will be:
50 pip (X) Rs 25 = Rs 1250
If you bought a standard lot then
The profit you would make is
50 pip (X) Rs 250 = Rs 12500
Forex Trading Risks
Like with every good thing, there is an equally bad thing lingering in the corners, Forex Trading has its risks. If you want to enjoy the profits, you have to evaluate these risks carefully and strategically.
Following are the risks associated with Forex Trading:
1. Country Risk
Country risk helps understand the risks associated with a particular country. Before investing in currencies, one must assess the structure and stability of the issuing country. In underdeveloped and developing countries, such as Pakistan, have their currency fixed to a world leader like the US Dollar or GB Pounds.
In this case, the central banks of the country need to maintain adequate reserves so that the country’s currency value does not fall. Currency crises can occur when there is a frequent balance of payment deficits. This can have huge effects on foreign exchange rates.
2. Leverage Risk
Leverage refers to a small initial investment, which is mandatory and is known as a “Margin” which helps us to gain access to substantial trades in foreign currencies.
Leverage is used to increase profits but it can also increase losses, How? If there is a small price fluctuation, the investor has to pay an additional margin called a “Margin Call”. During high volatility in the market, using leverage can lead to high losses.
3. Interest Rate Risk
This one is simple, if a country’s interest rate rises, its currency will rise in value. Similarly, if a country’s interest rate will fall, its currency is also going to fall. The interest rates of a country can significantly impact its exchange rate.
A wise investor can predict a sudden change in rates by the central bank and react to them which in turn can lead to higher profits.
4. Political Risk
Political events such as elections and protests play a vital role in fluctuating the currency value of the country. For instance, during election season, there is uncertainty in the country which leads to higher volatility in currency prices.
We cannot ascertain if the prices will increase or decrease but we can minimize our risk by being aware and investing in foreign currency wisely.
5. Transaction Risk
Generally, transaction risk occurs due to time differences between the start and completion of the contract. Forex trading happens on a 24-hour basis which can result in exchange rates changing before the contract ends.
If time differences increase, it gives more time for the exchange rate to change leading to bigger losses. So try to close the transaction as quickly as possible.
6. Counterparty Risk
The counterparty in a financial transaction is the company that provides the asset to the investor i.e the buyer who sells the asset to the investor. Every transaction must have a counterparty i.e a buyer who wants the asset paired up with a seller who wants to sell the asset.
In simple words, the counterparty risk refers to the risk of default by the buyer who provides the asset to the investor. During volatile market situations, the counterparty may be unable or might refuse to adhere to the contract.
Although Forex Trading has the highest trading volume, the risk associated with it is a lot. Investors should always be on the lookout for risks such as initial fee leverage risk, time differences, political, country as well as counterparty risks to ensure they don’t face losses.
Best Way To Learn Forex Trading
The best way to learn about forex trading in real-time is to start putting money in the system, but putting money right away might lead to staggering losses as you don’t have the practical experience and adequate knowledge.
So what do you do?
You can use a forex simulator that lets you trade fake money and buy fake currencies at market prices. So there is no actual financial risk for you and you still learn how to invest in Forex Trading.
Understanding forex, in the beginning, will be difficult as it requires you to know the value of various currencies and the pip value of those currencies. But the best approach I suggest is to download a fake forex simulator where you can buy and sell a lot of currency pairs in real-time using fake money.
If you invest your time to learn all the intricacies of forex, I’m sure you will find it extremely easy to operate and then you can shift to real trading using real money.
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