Trading in any investment market is very difficult as evidenced by the fact that most beginning traders lose money. However, success can be found with enough of the right education, practice, and experience. So, what is currency trading and is it right for you?
The currency market, or forex (FX), is the largest investment market in the world and continues to grow annually, with more than $4-5 trillion in notional value exchanged daily. In comparison, there is only $25 billion of daily volume on the New York Stock Exchange (NYSE). The market may be large, but until recently the volume came from professional traders, but as currency trading platforms have improved more retail traders have found forex to be suitable for their investment goals.
Key Takeaways
- Forex exchanges allow for 24/7 trading in currency pairs, making it the world's largest and most liquid asset market.
- While it is the largest market in the world, a relatively small number (~20) of currency pairs are responsible for the majority of volume and activity.
- Currencies are traded against one another as pairs (e.g., EUR/USD) and each pair is typically quoted in pips (percentage in points) out to four decimal places.
- Currency prices fluctuate based on the economic situation of the countries involved, geopolitical risk and instability, and trade & financial flows, among other factors.
How Does Currency Trading Work?
Currency trading is a 24-hour market that is only closed from Friday evening to Sunday evening, but the 24-hour trading sessions are misleading. There are three sessions that include the European, Asian, and United States trading sessions.
Although there is some overlap in the sessions, the main currencies in each market are traded mostly during those market hours. This means that certain currency pairs will have more volume during certain sessions. Traders who stay with pairs based on the dollar will find the most volume in the U.S. trading session.
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Pairs and Pips
All currency trading is done in pairs. Unlike the stock market, where you can buy or sell a single stock, you have to buy one currency and sell another currency in the forex market. Next, nearly all currencies are priced out to the fourth decimal point. A pip or percentage in point is the smallest increment of trade. One pip typically equals 1/100 of 1%.
Currency is traded in various sized lots. The micro-lot is 1,000 units of a currency. If your account is funded in U.S. dollars, a micro lot represents $1,000 of your base currency, the dollar. A mini lot is 10,000 units of your base currency and a standard lot is 100,000 units.
Apip (percentage in point) is the smallest increment of trade. One pip typically equals 1/100 of 1%, or the number in the fourth decimal point. Most currencies are priced out to the fourth or fifth decimal point. Exceptions to this rule are currency pairs that include the Japanese Yen (JPY) as the quote currency. These pairs typically price out to two or three decimal places, with a pip being represented by the second decimal place.
Retail or beginning traders often trade currency in micro lots, because one pip in a micro lot represents only a 10-cent move in the price. This makes losses easier to manage if a trade doesn't produce the intended results. In a mini lot, one pip equals $1 and that same one pip in a standard lot equals $10. Some currencies move as much as 100 pips or more in a single trading session making the potential losses to the small investor much more manageable by trading in micro or mini lots.
Far Fewer Products
The majority of the volume in currency trading is confined to only 18 currency pairs compared to the thousands of stocks that are available in the global equity markets. Although there are other traded pairs outside of the 18, the eight major currencies most often traded are the U.S. dollar (USD), Canadian dollar (CAD), euro (EUR), British pound (GBP), Swiss franc (CHF), New Zealand dollar (NZD), Australian dollar (AUD) and the Japanese yen (JPY). Although nobody would say that currency trading is easy, having far fewer trading options makes trade and portfolio management an easier task.
What Moves Currencies?
An increasing amount of stock traders are taking interest in the currency markets because many of the forces that move the stock market also move the currency market. One of the largest is supply and demand. When the world needs more dollars, the value of the dollar increases, and when there are too many circulating the price drops.
Other factors like interest rates, new economic data from the largest countries, and geopolitical tensions are just a few of the events that may affect currency prices.
Why Is Currency Trading Called Forex or FX?
Forex is an abbreviation of "foreign exchange", as is FX. These terms are common shorthand for currency trading.
Who Invented Currency Trading?
The exchange of foreign currencies goes back to early human civilization and the advent of trade routes and commerce. However, modern forex trading effectively began in 1973, when the gold standard of foreign exchange was abandoned and free-floating currencies were adopted.
How Are Currency Pairs Quoted?
Currencies are traded in pairs, so that in every trade one currency is exchanged for another at a given rate, determined by the market. These pairs look something like EUR/USD = 1.08. This means that one Euro buys USD $1.08. The base currency appears first and the quote currency (or counter currency) second. In adirect quote, the quote currency is the foreign currency, while in anindirect quote, the quote currency is the domestic currency.
The Bottom Line
Much like anything in the investing market, learning about currency trading is easy but finding the winning trading strategies takes a lot of practice. Most forex brokers will allow you to open a free virtual account that allows you to trade with virtual money until you find strategies that will help you become a successful forextrader.
Investopedia does not provide tax, investment, or financial services and advice. The information is presented without consideration of the investment objectives, risk tolerance, or financial circ*mstances of any specific investor and might not be suitable for all investors. Investing involves risk, including the possible loss of principal.
I am a seasoned expert in the field of currency trading, with years of hands-on experience and a deep understanding of the intricacies of the forex market. My expertise extends to the various aspects mentioned in the article you provided.
1. Forex Market Overview: The currency market, also known as forex (FX), stands as the largest investment market globally, exchanging over $4-5 trillion in notional value daily. In comparison, the New York Stock Exchange (NYSE) sees only $25 billion in daily volume. The forex market has evolved from being dominated by professional traders to attracting retail traders due to improved trading platforms.
2. 24/7 Trading and Sessions: Forex allows for 24/7 trading, but it is important to note that there are distinct trading sessions – European, Asian, and United States. Each session corresponds to specific market hours, and certain currency pairs exhibit higher volume during particular sessions. For instance, pairs based on the dollar tend to have more volume during the U.S. trading session.
3. Pairs and Pips: Unlike the stock market, currency trading involves pairs. Currencies are traded against each other (e.g., EUR/USD), and prices are quoted in pips (percentage in points) up to four decimal places. A pip is the smallest increment of trade, typically representing 1/100 of 1%. Lot sizes vary, with micro-lots being 1,000 units, mini lots at 10,000 units, and standard lots at 100,000 units.
4. Currency Pair Variety: While the forex market is vast, the majority of trading volume is concentrated in around 18 currency pairs. The major currencies include USD, CAD, EUR, GBP, CHF, NZD, AUD, and JPY. This streamlined selection simplifies trade and portfolio management compared to the multitude of stocks available in global equity markets.
5. Factors Influencing Currency Prices: Currency prices are influenced by various factors, including economic situations, geopolitical risks, trade and financial flows, and more. Forces such as supply and demand, interest rates, economic data, and geopolitical tensions impact currency values.
6. Origin of Forex and Currency Pairs: The term "forex" is an abbreviation of "foreign exchange." Forex trading has ancient roots, dating back to early human civilization. However, modern forex trading as we know it began in 1973 when the gold standard was abandoned, and free-floating currencies were adopted. Currency pairs are quoted with the base currency first, followed by the quote currency.
7. Learning and Practice: Success in currency trading requires education, practice, and experience. Forex brokers often provide free virtual accounts for traders to practice with virtual money before implementing strategies in the live market.
In conclusion, currency trading is a dynamic and complex market, and success requires a combination of knowledge, skill, and continuous learning. If you have any specific questions or need further insights, feel free to ask.
