Currency trading (forex)

This article discusses the principles of currency trading. At first sight currency trading (also known as forex trading) may look a bit complex, however, the basics are not that complicated. Currency trading is all about exchanging one currency for another on the forex market. For example, when somebody changes money to enjoy a nice holiday, or when a firm purchases something abroad, both are transactions on the currency market. The forex market only exists by the grace of such transactions. Currency trading distinguishes itself from other financial markets, like equity or bond trading, as it lacks any regulating organization and there is no forex exchange. The forex market is the internal market for banks; Interbank market. For that reason, trading forex for money has traditionally been complicated. However, the worldwide web provided unlimited opportunities to establish a connection between currency traders and the thrilling forex trading.

Main currency pairs
Let’s take a closer look at Forex trading. Every currency has a floating rate. Trading a currency is always attended with selling or buying another currency. For that reason, currency trading is always carried out in pairs of two currencies, like EUR/CHF or GBP/USD. Although there are globally many currencies, only a few currencies are traded and utilized worldwide, which are obviously the most interesting currency pairs in terms of profitability and liquidity. The main currency pairs are: USD/CHF, USD/JPY, USD/EUR, EUR/CHF, GBP/USD.
These five currency pairs cover more than 85% of all currency trade transactions. Therefore, it is very legitimate that most forex traders mainly focus on one or more of these currency pairs. Nevertheless, there are also less popular currency pairs, the so-called ‘exotic pairs’, which can also be profitable if you have sufficient currency trading knowledge.

Leverage system
A currency trade consists of buying one currency and selling one currency. If a trader expects that the value of one currency will increase, he will buy that currency with another currency. For example, if a trader believes that the Euro’s value will appreciate, he may buy Euros with US Dollars. If the value of the Euro appreciates versus the US Dollar, he will change its Euros back into US Dollars. This is the way traders make money.
Let’s say that the forex trader bought 10 Euros for 10 US Dollars. In this case, the trader sold US Dollars and bought Euros. Should the relative value of Euros appreciate to 15 US Dollars, the trader can sell its Euros and purchase US Dollars back. The trader’s profit will be 5 US Dollar, given the fact that he only paid 10 US Dollars.
This system will be more powerful in combination with leverage, which applies borrowed money to finance investments. In currency trading it’s normal to leverage trades up 100 times. This implicates that with a USD 1.000 deposit, a forex trader can trade for USD 100.000. The leverage mechanism is one of the main reasons why forex trading is so popular.