Forex trading refers to the buying and selling of currencies to take advantage of the price movements and volatility of the forex market.
The forex market is very dynamic and fast-paced with lots of transactions every day. Traditionally, the forex market was used by central banks, commercial banks, large companies, and other such institutional players. However, thanks to the advancement of technology, now even individuals can actively trade in the forex market and benefit from the price movements.
Example 1: Forex traders aim to buy a currency pair at a lower price and sell it at a higher price. So, a forex trader may buy a EUR-USD currency pair for 1.2364. If the price of this pair goes up to say 1.3024, the trader will sell it off for a profit.
Trading in the forex market is always done in pairs in which one currency serves as the money and the other currency serves as a commodity. So in the currency pair USD-GBP, GBP is the money, and USD is the commodity. Just like you pay 1 GBP to buy a 2 litre bottle of Pepsi, you can buy 1 USD for GBP 0.628 (as of November 2014).
While you can buy and sell any currency in the forex market, trading is usually dominated by a few currency pairs.
As the volumes are concentrated around a few currency pairs, forex trading is much easier as opposed to say equities. Because in equities, you have to track the movements of many stocks. Whereas in forex trading, you just need to focus on the prices of the most-traded currency pairs.
Like all financial markets such as equity, commodities or futures, forex trading also involves risk. Forex trading is riskier especially because of the high amount of leverage provided by brokers. Using leverage, investors can buy up to 100 times their original investment. If things go wrong, this can lead to huge losses to forex traders.
Before starting, investors should carefully understand the risks of forex trading.
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