Forex trading and brokers: basic understanding

Understanding Forex

Foreign exchange could mean a lot of things. It could be an act of exchanging currencies at a bank or it could imply trading fiat currencies with different traders in the foreign exchange market. The value of all the major currencies that are traded in the forex markets is determined through the exchange rate. 

Remember that in the forex market, all fiat currencies are traded in pairs like USD/JPY, EUR/INR, USD/CAD, etc. As a prevalent norm, these currency pairs are traded in three different types of lots: micro, mini and standard where the worth of each lot is as follows:

  1. Micro lot: 1,000 units
  2. Mini lot: 10,000 units
  3. Standard lot: 100,000 units. 

While there are several reasons that make the foreign exchange market very unique, the sheer size and trading volume of this financial market surpass every other. The Bank for International Settlements, co-owned by 63 central banks estimated that the daily trade forex in April 2019 was worth $6.6 trillion. London, New York, Singapore, Hong Kong, and Tokyo are the biggest forex trading hubs in the world. 

Trading in the market

The forex market offers incredible flexibility to traders as it operates 24 hours a day from Monday to Friday at a global level. It allows you the liberty to make a sale or purchase at literally any point in time in the day. Unlike the share market, trades are not time-bound in forex. Forex trading is all about buying and selling currencies that may not necessarily be of your own country. However, note that all transactions are digital and there’s no physical exchange of currencies. Forex traders speculate on different currencies, expecting to make a profit when the value rises. 

Example of Foreign Exchange

When you’re trading in the forex market, you should look at macro indicators that may affect currency rates. For instance, as a trader, you realise that the European Central Bank (ECB) could ease its monetary policy soon. This is perhaps because of the Eurozone’s economic pace and so you feel that the euro’s position will weaken against the U.S dollar. Therefore, you sell short for €100,000 at an exchange rate of 1.15. In a few weeks’ time, your prediction actually comes true and thus you end up making a profit of $5,000.

So in this case, you shorted €100,000 and then took $115,000 for what is known as a short sale. Since the market movement was in your favour, you made a profit and it cost you only  $110,000 to buy the currency again. However, if the opposite had happened where the Euro became stronger, you would have incurred a loss. 

Individual investors cannot directly trade in the forex market. They have to do so through a forex broker that’s basically a company that mediates the transactions. It helps to have a good forex broker because not only will it give you access to market resources but will also provide a user-friendly trading platform. However, along with the ever-growing number of traders in the market, there are also numerous scammers in the market.

Therefore when you explore the forex brokers online, you must choose a broker that aligns with your trading style and is also regulated. 

Things to keep in mind when selecting a forex broker: 

1. Safe and reliable

If your broker is not registered with the concerned regulatory body that operates in your country, your money is not in the right hands. This implies that you will have no backup or insurance in case of any untoward incident. Finding a broker you can trust is important. You can do this by checking they have: 

  • A consistently good reputation
  • Your country’s regulatory body has them registered. This will protect your investment from potential fraud. 
  • Having a broker who is listed on the stock exchange is a positive sign. It implies that the company is accountable to the public and has to stay relevant to ensure its stock prices remain at a high position.

2. Brokerage fee

While you have to pay a fee to your broker for every trade you undertake, make sure that fee is not unusually high. Low brokerage ensures that you benefit from the profits made on your trade. 

Be aware of all the hidden costs or fees that come with your trading account. Check if your broker charges you withdrawal fees for transferring funds to your bank account or if it is deducting a penalty for prolonged inactivity on the account. 

3. Platform interface

Having an easy-to-use interface is a must on every trading platform. Your broker should be able to provide you with a good, clean, and comprehensive interface that is free from bugs and lags. 

Never underestimate the importance of a good trading platform as it gives you access to the live market. You should be able to access all features and find all the products in a hassle-free way. 

4. Educational resources

It is an added bonus and of course, a great feature if your trading platform hosts educational content such as articles, infographics, explainer videos, etc. While you learn, you can also make the most of the demo trading accounts to apply your knowledge and strategy to sense how it could take shape in the real forex market. 

5. Backup and Support

In order to make bigger trades and earn more profit, brokers may even allow you to borrow money. Check if your brokerage offers Negative Balance Protection, which would keep your balance from going negative, i.e it will prevent you from getting into debt. 

There’s no substitute for good customer support. You will always benefit from having people who are responsive to your concerns and have a sound knowledge of the trade.

The Bottom Line

Buying and selling different currencies is the key aspect of the forex market. On an everyday basis, forex transactions play an important role in determining the value of different currencies. The forex market operates at an interbank as well as at an over-the-counter level. Since the volume of trades is huge, they also have a huge impact on the foreign exchange rates. 

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