An understanding of the working of the Forex market will automatically help you understand how you can make money trading Forex. Forex is a market where one can buy and sell currencies. And, for doing this, you cannot deal with only one currency; instead, you will need two currencies to purchase or sell a currency. Basically, here you will be trading currency pairs.
Placing a trade in Forex is same as putting a trade on any other exchange market (like the stock market).
What’s the objective?
Well, the objective of the Forex market is to trade one currency for another currency in the expectation that the value of the purchased currency will increase in the future in relation to the other currency of that pair. If you weren’t able to pick that line-up, here is an example for the same.
Let’s say the current market price of EUR/USD is 1.1200, and you are willing to buy this pair at this rate. So, you purchase 10,000 euros at 1.1200. This 10,000 euros in USD will be, 10,000 euros * 1.1200 = $ 11,200. Now, let’s say after a week, the price becomes 1.2000. So, when you sell these 10,000 euros, you will receive 10,000 euros * 1.2000 = $12,000.
Here, when you had bought 10,000 euro, you had indirectly sold $11,200, and when you sold these 10,000 euros, you would have received $12,000. Therefore, you basically made a profit of $800 ($12,000 – $11,200). Are you still lost? Well, let’s understand it step by step.
Reading a Forex Quote
As mentioned, currencies in forex are always quoted in pairs. This is because, in every trade in forex, you are simultaneously buying one currency and selling another.
Let us understand it with an example. Consider the pair EUR/USD. Here, the left currency (EUR) is known as the base currency, and the right currency is known as quote currency or counter currency (USD). So, in simple terms, when you’re buying EUR/USD, you are actually buying EUR and simultaneously selling USD.
What does the current market price tell you?
In the above example, the current market price of EUR/USD was 1.1200. When buying this pair, the exchange rate tells you how many USD you need to pay in units to buy ONE unit of EUR. So, here, to buy 1 EUR, you need to pay 1.1200 USD.
When to buy or sell a currency pair to make a profit?
- You need to buy a currency pair when you believe that the base currency is going to appreciate in the future.
- Similarly, you need to sell a currency pair if you feel the base currency will depreciate in the future.
What is “long” and “short”?
In trading, you either buy a currency pair or sell a currency pair. However, in the financial and forex market, a buy position is called a long position and a sell position is called a short position.
So, all you need to remember is that buy=long and sell=short.
Concept of Bid, Ask & Spread
This is where the brokers enter the business. There are two prices in the market, the bid price and the ask price.
The bid is the price the broker is ready to buy the base currency from you in exchange for the quote currency.
And, the ask is the price your broker willing to sell the base currency to you in exchange for the quote currency. In other words, if you want to buy something, the broker will sell it to you at the ask price.
Finally, the spread is the difference between the bid and the ask price. For example, if the bid price of EUR/USD is 1.1200, and the ask price is 1.1202, the spread for this pair will be 2 (pips) (1.1202 – 1.1200).