How to Trade Forex
Forex is traded in a virtual market space. Which means there’s nothing like a ‘forex stock exchange’. All trading happens electronically, over telephone, and now online.
Largely, forex trading is automated, which means the buying and selling is pre-programmed by means of automated software available with retail traders.
Because it is a virtual market, the FX market is open 24 hours a day, 5 days a week. This means that you (through your broker) could be buying and selling at 3 a.m. in the morning via the phone or over the internet.
Trading in Foreign Exchange
Trading in Foreign Exchange is no different than trading any kind of commodity. If you’ve traded the share market, you already know the basic rule: Buy when the price is low, sell when the price is high.
In the FX market, too, you will buy a currency if you think its value is going to fall and will sell it, when you find its value rising.
Here’s a simple example:
We already know that currencies are traded in pairs. Let’s consider the EUR/USD pair. The EUR/USD rate is 1.432.
This means you will be able to buy 1 Euro by paying $1.432. This exchange can change by quite a few pips in a matter of seconds.
When you buy or sell currency, you do it in ‘lots’. A lot is equal to 1,000 units of base currency. If you’re trading the above mentioned EUR/USD pair, it means you will be buying EUR 1,000 for USD 1,432.
So how do you make a profit? It’s quite simple. Suppose you buy 1000 Euros for $ 1,432. Two days later, the exchange rate goes up to 1.558.
This means you can now, sell the 1000 Euros, for $1558. You make a net profit of $ 126.
Suppose you had bought 10 lots of the Euro, you profit would be ten-fold, i.e. $1260. Essentially, if you think the base currency is going to go up in value, you will buy it; if you know it will depreciate, you will sell it.
Bid Price vs Ask Price
The exchange rate or the FX quote for a currency pair comes with two values or prices – called the bid price and the ask price.
While trading, the EUR/USD pair will generally be quoted thus: EUR 1 = USD 1.432-38. 1.432 is the bid price, at which you will be willing to sell the base currency. 1.438 is the ask price, at which you will be willing to buy the base currency. The bid price is always lower than the ask price.
While trading forex, you will need to know the bid price at which you are willing to sell the base currency. When the exchange rate falls to this price, your broker will sell off the base currency. Similarly, when the rate reaches an ask price you’ve specified, your broker will buy the base currency.