How to earn money in FOREX market
Most beginners get into trading straight away and lose money. Some others think they are luckier than others and are naturally gifted and then they lose. Success from trading is all about putting the logic over your emotions. Understanding the basics of FOREX trading and getting started will ensure that you are more organized. First step is to start learning. As you are reading this article, rest assured that you are at the right place to get your basics right even before you enter into trading.
So, let’s fasten our seat belts and get started. Forex also known as FX (Abbreviation for Foreign Exchange) is nothing but relative value of one currency versus another one. Let’s take a simple example. We all go for vacations and enjoy it mostly when we visit other countries. Don’t we? That’s because we get to learn and know about differences whether it be in culture, tradition or food. Among all the differences, one major difference we find is the currency and its value. Let’s assume you travel from UK to Australia for a vacation. GBP being the currency of UK, you carry 500 GBP with you. But once you arrive in Australia you find that you cannot do anything with the 500 GBP unless you convert it into Australian Dollars. Now what do you do? Very simple, convert the 500 GBP to AUD in a foreign exchange. Assume that the conversion rate is 2.10 which means,
1 GBP = 2.10 AUD
Or in other words, to buy 2.10 AUD you need 1 GBP. So you pay 500 GBP and you get 500*2.10 = 1050 AUD. So you have just done a foreign exchange here.
Let’s assume all your trip was fun and you did not spend a single penny in Australia because you had a friend who took care of all your expenses. Oh Wow!! I wish I too had a friend like that. Ok, now when you get back home after the vacation you find that the value of GBP has gone low to 2 AUD which means,
1 GBP = 2.00 AUD
Thus, upon exchanging the 1050 AUD, you get 1050/2 = 525 GBP. GBP has gone down with respect to AUD and hence you make a profit of 25 GBP. Yes, it’s that simple.
Now let’s try to understand how traders trade on foreign exchange. Forex prices are always quoted in currency pairs. One currency is bought in exchange of the other and together these two currencies form a pair known as currency pair. Each currency pair represents a trading product and is denoted as ABCXYZ or ABC/XYZ, where ABC and XYZ are 3 letter code for the currencies involved in the transaction. The first currency in the pair (ABC) is called the base currency or the primary currency. The second currency in the pair (XYZ) is known as the quote currency or the counter currency.
The base currency is quoted relative to the counter currency i.e. ABC/XYZ is the price of ABC expressed in XYZ. To make it more clear let’s consider an example,
GBP/AUD = 2.10
This is the price of GBP expressed in AUD, meaning 1 Pound is worth 2.10 Australian Dollars. This is called a Forex Quote and it means that to buy one pound, you would have to sell 2.10 dollars and if you sold one pound you would receive 2.10 dollars. Thus, the base currency acts as the basis for the trade.
Consider an example where a trader speculates that GBP will rise against the AUD and decides to enter into a trade. He buys £100 of GBP/AUD at 2.1, which means he pays a total of $210. A few weeks later, as expected the trader finds that the price has raised to 3.0, meaning his £100 is now worth $300(100 X 3.0). So, the trader decides to sell £100 of GBP/AUD at 3.0 and makes a profit of 300-210 = $90.
In the first case when the trader bought GBP, he has gone long on GBP/AUD in the Forex market. Which means he would buy GBP and sell AUD simultaneously. And in the second case when the trader sold GBP, he has gone short on GBP/AUD which means selling GBP and buying AUD.
When you are buying a currency pair expecting the base currency to rise in future, you are going long or taking a long position and when you are selling a currency pair expecting the base currency to fall, you are going short or taking a short position. Also, when a currency pair is traded, the quote will always include two prices: Ask Price and the Bid Price. You can buy one unit of the base currency at the Ask Price and sell one unit of the base currency at the Bid Price.
In general, Bid Price represents the maximum price that a buyer is willing to pay and Ask Price represents the minimum price sellers are willing to receive. Ask Price is also referred to as the Offer Price.
Consider the following Forex quote: USD/AUD = 1.3900/03
The quote before the slash (/) is the bid price and the two digits after the slash is the ask price. Only the last two digits of the ask price are shown in a quote. Hence, the quote above means:
Bid = 1.3900 Ask= 1.3905
As per the Ask price, you can buy one USD for 1.3905 AUD.
The difference between bid and ask price is called the spread. In the example above, the spread would be 0.0005. A spread represents the difference between purchase and sale rates. If the market is highly liquid for a stock, which means the stock is being heavily bought and sold, then the bid-ask spread will be lower. Thus, the spread is an indicator of the liquidity. In general, the smaller the spread, the higher will the liquidity. Spreads in Forex trading are usually expressed as pips. A PIP (Percentage In Point) is the smallest unit of price for any currency. As we have seen in the example above, currency values are stated to the fourth decimal point. A pip represents this smallest change in the fourth decimal place, 5 pips in this case also known as points.
Continuous analysis of markets through charts is one way to understand the trend in price movements. Sample charts below show trends in the market rate for currency value.
Forex trading has become very appealing because it offers several advantages over other markets.
- Foreign exchange market is highly liquid, which means large number of traders and massive volume of trades happening on a daily basis ensure that you will have a seller or buyer for the currency you wish to trade upon.
- Transaction costs are very low under normal market conditions, as there are no commission systems. Unlike other markets where there are no additional costs like broker fee, clearing fee etc.
- Currency fluctuations are very small on a daily basis and hence the foreign exchange is very less volatile. Hence investors can realize large profits even though market has moved by a very small percentage. Leverage allows a large amount of currency to be bought with a small investment.
- Forex trading ensures price certainty and instant trade execution as opposed to futures and equities markets. Thus, hedging your risk in Foreign Exchange is much easier than equity markets.
- A big benefit of Forex trading is that you can buy or sell any currency pair and make money when the market is trending up or down.
With the growth of Over the Counter markets (Market place where there is no centralized exchange involved), forex trading has now become more popular. The growing number of active forex traders along with the advantages offered by forex trading, have turned the currency market into one of the largest financial market in terms of total cash value traded.