Forex trading is not easy. Before you dabble into it, you should understand the basics of the business.

Introduction

Forex trading can be a lucrative career. However, before you can start expecting reaping returns, you have to first understand how it works. Many, thinking that it is an easy way of making money, have been attracted to Forex trading only to end up getting burned by it. You can choose not to become one of those.

To do so, you should dedicate yourself to learning the basics. According to statistics, over 90% of Forex traders lose their money and quit the business for good. Therefore, if you want to be different from those, if you want to succeed at Forex trading, you must be ready to give it your best — in education and practice.

Therefore, here are the essential basics of Forex trading that you must know as a beginner.

Currencies

What is traded in the Forex market? Money. Currencies. Forex market is the global market whose participants buy and sell currencies and attempt to profit from variations in their exchange rates. However, even though the Forex market is the financial market for currencies, not all currencies are traded equally.

The most heavily traded currency is the United States Dollar. Then come the Euro, Japanese Yen, Great Britain Pound, Switzerland Franc, Canadian Dollar, Australian Dollar, and the New Zealand Dollar. Consequently, these currencies are known as “major currencies.”

Currencies are generally represented by three letters: the first two stand for the bearing country while the last represents the currency itself. An example is the USD (United States Dollar).

Furthermore, every Forex transaction is conducted in pairs. That is, there must be two currencies for a Forex transaction to occur. As traders buy one currency so do they simultaneously sell another. Consequently, all the currencies available for trading are paired into:

  • Major pairs
  • Cross/Minor, and
  • Exotic pairs.

The major currency pairs are those that include the U.S. dollar in them. Because they are the most widely traded pairs, they also have the highest level of liquidity and the lowest trading costs. They are:

  • EUR/USD
  • USD/JPY
  • GBP/USD
  • USD/CHF
  • USD/CAD
  • AUD/USD
  • NZD/USD

The crosses, also known as the minors, are those currency pairs that do not include the U.S. dollar. Although not as widely traded as the major currency pairs, those among them based on EUR, GBP, JPY also experience a significant market action and are the most popular of them. They include:

  • EUR/CHF
  • EUR/CAD
  • EUR/AUD
  • EUR/JPY, etc.

Finally, the exotic currency pairs are the least traded of all. And because of that, they have the highest transaction costs of all of them. An exotic currency pair includes a major currency and the currency of one of the emerging economies such as Brazil or Mexico. Examples include:

  • USD/BRL (United States Dollar/Brazilian Real)
  • USD/MXN (United States/Mexican Peso)

At this juncture, it is important to highlight that the two currencies in each pair are known as the Base and Quote/Counter currencies respectively. The first of the pair is the base; the other is the quote/counter currency.

The base currency, as it is known, is the “basis” for each trade. That is, when you buy a currency pair, you are essentially buying the base currency. And when you sell the pair, you are essentially selling it.

Pip

The pip, short for “percentage in point, ” is a measure of the minimum value by which a currency pair can change. For example, assuming the pair EUR/USD changes from 1.1000 to 1.1002, the currency pair is said to have moved 2 pips. Except for pairs involving the yen, most currency pairs have their pip change represented by the last of the 4 decimal places in their price quotes.

In Forex trading, pip is used to represent losses and gains.

Leverage

When you trade with leverage, you will be able to control a large trading account with small capital. In short, when you trade on leverage, you use a small amount of money to open positions while your broker borrows you the rest.

Leverage is expressed in ratios. For example, when you use your deposited amount of $1,000 to open a position of $50,000, your leverage level will be 50:1. Here, 50:1 is your leverage while the $1,000 you deposited is your margin, the amount required by your broker to open a position.  

Bid-Ask Spread

For each currency pair, there are two different prices. These are the bid price and the ask price. The bid price is the price at which your broker is willing to buy from you. On the other hand, the ask price is the price at which it is willing to sell.

Hence, you sell at the bid price and buy at the ask. As earlier stated, the base currency is the “basis” for the transaction and you are either buying or selling it. The difference between the bid price and the ask price is called the spread, and it is the fee that accrues to the broker itself.

The pip, short for “percentage in point, ” is a measure of the minimum value by which a currency pair can change. For example, assuming the pair EUR/USD changes from 1.1000 to 1.1002, the currency pair is said to have moved 2 pips. Except for pairs involving the yen, most currency pairs have their pip change represented by the last of the 4 decimal places in their price quotes.

The spread which represents the charges of the broker is measured in pips, too. For instance, a EUR/USD quote of 1.2031/1.2033 indicates a spread of 2 which is the broker’s gain.

Lot Size

Forex brokers, intermediaries between Forex traders and the Forex market, provide three types of lot size. These are the

  • Standard lot
  • Mini lot
  • Micro lot

This classification is based on the number of currency units in each lot. For example, the standard lot contains 100,000 units of the base currency. A mini lot has just 10,000 units of the base currency while a micro lot, on the other hand, has 1,000 units of it.

Why is the lot size important? It is because it influences your potential for profit or loss. When you trade a high lot size account, you stand a higher chance of making higher gains or losses. That is, the larger your lot size, the greater your potential for a significant profit or loss.  

For example, in a standard lot, a change of 1 pip is equivalent to $10. For a mini lot, one pip is just $1.

Forex Trading Session

Although the Forex market is on for 24 hours, there are specific times of the day during which it is most active. In fact, these specific times have been grouped into the:

  • European,
  • Asian, and
  • The North  American sessions.

This categorisation explains why certain currency pairs are most traded during certain sessions.  For example, currency pairs based on the USD are expected to be most active during North American session.

Overview

There you go, the basics of Forex trading. Although the discourse here is not in any way, exhaustive, it is aimed to get you familiarised with the Forex market and its basic lingo. From here, you can take it up and get deeper into the technicalities. And trust us, we have a lot to teach.