An Introduction to FOREX
Foreign currency exchange, or Forex, is the largest financial market in the world. The electronic network of traders includes large institutions, banks, governments and individual traders. Trades are placed to speculate on future changes in currency exchange rates. Many of these are short-term day trades, lasting only seconds or minutes. Due to the high leverage, Forex trading is risky and trades are not usually held for long periods of time as is common in the stock market.
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Currency Pairs
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The trading instruments in Forex are "currency pairs." Traders can't simply purchase units of a single currency. They must speculate on the value of a currency against another. No currency has intrinsic value without a comparison against another. The Japanese yen may simultaneously rise against the Singapore dollar while falling against the British pound. The currency pair consists of a "base" currency followed by a "counter" currency, and the "price" of the pair is the exchange rate between the two. Thus the Euro/USD (U.S. dollar) pair may have a price of 1.3. This means that 1 euro equates to 1.3 U.S. dollars and 1,000 units of this pair is worth $1,300.
Leverage
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Exchange rates fluctuate continuously, but they do so by small amounts each day. To profit from short-term Forex trading, brokers provide high leverage to their clients. In the United States, this leverage is often a multiple of 1,000. Thus 1,000 units of a pair priced at 1.3 might be worth $1,300 but only requires $130 to purchase. This allows a $10,000 account to control 1 million dollars of currency. A small fluctuation in exchange rates carries great risk or reward when positions are this large.
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Account Types
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Because of the large risks associated with Forex trading, different account types are available to suit different risk scenarios. Most Forex accounts require minimum trade sizes of 100,000 units of a currency pair. This is called a "lot." However "mini" Forex accounts are popular and reduce the lot size to 10,000. However, even with a mini account the risks are high. Thus, "micro" Forex accounts, which trade in lots of only 1,000, are provided by some brokers. These accounts offer little risk and, in some cases, may be opened for only $25.
Technical Analysis
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Most Forex traders speculate on currency valuation using nothing more than price charts. In stock trading, investors may consider a company's balance sheet, earnings reports and other fundamental valuations when making investment decisions. In Forex, the market is so large and without such specific influences that few try to analyze currency valuation beyond studying charts. Pure chart-driven strategies are a part of the field of technical analysis. The field is large and complex, but traders learn to identify recurring patterns in the hope that they will repeat.
Volume
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Equity traders in stocks, futures and options often study trading volume in their analysis. Volume is a measure of the total number of transactions that occurred over a period of time. In the stock market, huge gains may be made one day and huge losses the next. However, if the volume on the negative day is much greater, this indicates a stronger bearish bias in the market. Forex trading is not centralized in any financial exchange. Thus, volume data is not tracked or available to Forex traders. For this reason, strategies that require volume information in other markets cannot be applied to Forex trading.
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