The foreign exchange or forex market is traded around the globe, virtually around the clock. Find out if the forex market is right for you with this retail forex guide for beginners.
Around the globe, and virtually around the clock. That’s one way to describe the foreign exchange (“forex”) market.
It's the exchange of one nation's currency for that of another. More than $5 trillion of currency changes hands every day and, since exchange rates are based upon nations’ interest rates, economics, and geopolitical conditions, rates are always fluctuating. It's a dynamic, global market.
If you're interested in learning how to trade forex, read on for a few things to know. But be forewarned: forex trading is subject to unique risks. And not all accounts will qualify. If you're a beginner interested in forex trading, you may wish to begin with a primer on the dynamics of currencies and the marketplaces where currencies trade. Later on, we'll show you how to practice trading forex without risking a dime.
In general, retail clients have two choices in terms of trading currencies:
When trading forex, you’re not just trading one product; you’re trading two currencies against each other. The ratio of the two is what's known as a currency pair. The quote for a forex currency pair references what it costs to convert one currency into the other. For example, suppose the U.S dollar versus the Canadian dollar (USD/CAD) is trading at 1.33. That means $1 USD is equal to $1.33 CAD. And if you want to know how much it would cost you to buy a Canadian dollar, you invert it: $1/1.33 = $0.7519. So in this example, it costs a little over 75 cents to buy a Canadian dollar.
FIGURE 1: FOREIGN EXCHANGE FUTURES. Sample quote of CME Group's British pound futures (GBP/USD) on the thinkorswim®futures platform. For illustrative purposes only.
In other words, with currency pairs, it’s all relative. Here are a few more nuggets regarding forex quotes.
Forex trading involves leverage, which means you can control a large investment with a relatively small amount of money. When you buy or sell retail forex or foreign exchange futures, you don't put up the entire notional value, but rather you post an initial margin requirement—essentially a "good faith" deposit. In forex, margin requirements vary as a percentage of notional. Margin requirements are typically between 3-5% of the notional value, however certain pairs can be as low as 2%. Leverage is a double-edged sword, as it can magnify both your profits and your losses. A small amount of market movement can have a large effect—positive or negative—on the account's P/L. Adam Hickerson, Manager, Futures and Forex, TD Ameritrade, suggests," If you're a beginner who's starting out in the forex market, it's important to define your risk tolerance before you enter into a position. The leverage in the forex market can magnify profits and losses, but if you have a plan in place and define your risk tolerance, you can better manage the risks associated with leverage."
Forex rates are based on interest rate differentials between the currencies making up the pair. So when you make a trade, you’re essentially “long” one currency and “short” the other. When you carry a position from one day to the next, you earn interest on the currency you’re long and you pay interest on the currency you’re short.The differential between the two interest rates amounts to what’s called your “net financing rate.”
Before carrying a forex position from one day to the next, it's essential you learn the ins and outs of forex financing rates.
Does trading forex sound exhilarating? Daunting? A bit of both? Start with simulated forex trading on the paperMoney platform on thinkorswim. This will allow you to practice, test strategies, and learn the dynamics of this asset class without risking a dollar, pound, yen, or euro.
Doug Ashburn is not a representative of TD Ameritrade, Inc. The material, views, and opinions expressed in this article are solely those of the author and may not be reflective of those held by TD Ameritrade, Inc.
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