Lesson 1: Fundamentals, Functioning and Vocabulary of Forex Trading

Under this barbarous term is hidden the abbreviation of "Foreign Exchange" (For-Ex), which designates the foreign exchange market, or the "currency exchange" to make it simpler.

We have all been dealing with Forex in a roundabout way when traveling abroad, exchanging currencies, and we all also noticed that exchange rates fluctuate.

These are precisely those variations that forex traders make use of.

Forex is therefore the place of virtual exchange of currencies, whose value fluctuates constantly, 5 days on 7 and 24 hours on 24 (the forex is the only market open 24 hours a day , and it is therefore possible to Do trading at night).

Before discussing forex trading properly speaking, and the techniques that will enable you to carry out successful operations, you must understand the general functioning of this market, its specificities, and become familiar with the vocabulary used.

We will therefore review here the main terms used by forex traders, explaining in detail the essential notions in currency trading.

Point 1: Currencies are quoted by "pairs"

Unlike other financial assets, currencies are quoted in pairs. It is always the value of a currency expressed in another currency.

As a consequence of buying or selling a currency pair, we are betting on the rise of one currency, but also simultaneously on the decline of the other currency.

Example

When buying EUR / USD, we are betting on the rise of the Euro against the Dollar, which means that we are also betting on the fall of the dollar against the euro. The motivations for buying EUR / USD may therefore result from either a bullish notice on the Euro or a bearish view on the Dollar. 
Conversely, when you sell EUR / USD, you bet on a fall of the euro against the dollar, which implies that you are also betting on the rise of the dollar against the euro. The motivations for selling EUR / USD can therefore be the result of either a bearish opinion on the euro or a bullish opinion on the dollar.

Point 2: One can bet on the fall of a currency pair as easily as on the rise

We have just talked about "selling" the EUR / USD, which perhaps implies for you that you have to have previously purchased it. However, this is not the case. On the forex, it is possible to take a short position on a currency pair without having "in stock" that currency pair.

This mechanism is known on the equity markets as "short selling". It is really a "game of commitment". By taking a short position, you agree to "provide" a currency pair at the time of your position, at the time you want to close the position.

Therefore, if you take a EUR / USD position at 1.20 and close it at 1.10, this amounts to buying at 1.10 what you previously pledged to sell at 1.20, The difference constituting your profit.

However, on the trading platform, betting down is just clicking on "selling" instead of "buying", it's just as simple as that!

Point 3: The performances are counted in pips and the quantities in batches

Forex traders calculate variations in "pips", not percentages, and currencies are bought by "lots".

1 pip equals the last decimal place of a currency:

Example

EUR / USD rose from 1.2750 to 1.2800, said it earned "50 pips"

This method of calculating variations is indeed preferred on the forex because in percentages, currency fluctuations are difficult to read because of their low nominal volatility.

For example, when the euro rose from 1.2545 to 1.2565, the change was only 0.16% (20 pips).

You should also know that currencies are bought in lots. Most brokers offer lots of different sizes, ranging from 1000 (micro batch) to 100,000 (standard batch).

It is also easier to calculate the losses and profits with the pips, because one knows the value of 1 pip depending on the size of the lot on which trading operations are carried out.

Example: EUR / USD

-Lot of 1000 units: 1 pip = 0.1 USD 
-Lot of 10000 units: 1 pip = 1 USD 
-Lot of 100000 units: 1 pip = 10 USD

So, when we won 20 pips by having traded a lot of 1000 units, we won 2 dollars, 20 dollars with a lot of 10,000 units, and 200 dollars with a lot of 100,000 units.

Point 4: It is possible to bet on amounts well above its capital thanks to the leverage

We have just seen that the minimum lots on the forex are lots of 1000 units, that is $ 1000 for the EUR / USD, but that does not mean you have to have that amount on your account to take the position .

This is where the famous "leverage effect" comes in, one of the main advantages of forex trading.

To make it simple, leverage allows you to have more money to invest in forex than you have on your account.

For example, a leverage of 100 means that you can invest on amounts 100 times greater than what you deposited into your trading account.

With 1000 dollars, you can invest on an amount of 100,000 dollars, if you have a leverage of 100.

This is indeed where one of the main advantages of Forex is located, and it is thanks to leverage that Forex is a market that can (on paper) make you rich overnight, Even with a minimal start (extremely rare in reality, but theoretically possible).

It is also because of the very important leverage that the forex offers that it is considered an ultra speculative market and very risky for the uninitiated.

Example

With a credited account of $ 1,000 and a leverage of 100 (brokers typically offer 50 to 500), one can invest in an amount of $ 100,000 ($ 1000 X leverage 100).

Point 5: Trading on margin

The margin refers to the amount to be "mobilized" to carry out an operation. Basically, this is the amount of your lot, divided by leverage.

When you buy a batch of 1000 dollars with a leverage of 100, you only mobilize 10 dollars. In other words, you only mobilize one hundredth of the size of your operation ($ 100 / leverage 100). The $ 10 used is called the "margin".

A small calculation will be more useful: 
- Purchase of a lot of 10000 units when EUR / USD is 1,3000 
- Leverage of 100 
- Capital mobilized: 10000/100 = 100 dollars (you must have a minimum of 100 dollars on Your account to take that position). 
- If EUR / USD increases from 1,3000 to 1,3100 (current variation in one day), the gain is 100 pips 
- 100 pips X 1 dollar (value of 1 pip on a lot of 10,000 EUR / USD units) 100 dollars 
Having actually invested 100 dollars, the final gain is therefore 100 dollars, which represents a performance of + 100% compared to your real investment (margin mobilized).

Knowing that the Forex is a very volatile market, and that it is common to see daily variations of more than 100 pips, it is easy to understand that the gains can accumulate at an extraordinary speed (as well as losses elsewhere ... ).

Point 6: Spreads instead of transaction fees

The quotation (price, price) of a currency pair at a specific time differs according to the direction of the transaction: Purchase or sale.

The difference between the purchase price (Ask) and the selling price (Bid) is called Spread.

In this example, it is said that the spread of the EUR / USD pair is 1 pip.

In practice, this means that if you make a purchase, then close that position immediately without the neighbor moving, you lose 1 pip, as well as if you make a sale and close it immediately.

This also means that as part of a purchase, your position starts to be profitable after a 1 pip rise (and after a 1 pip drop if you decided to sell).

This difference, known as spread, is the remuneration of your broker.

At FXCM for example, the spread on EUR / USD passes regularly under 1 pips. But beware, some brokers do not hesitate to apply a spread of 3 pips! Do not forget, the lower the spread, the better!

In the end, a particular market, but with many advantages

Even if some of these concepts are found in other markets, it is understandable that Forex has its specificities, which are all advantages.

This can impress the neophytes, but we do it very quickly, and if all apprentices traders do not necessarily become good traders, all of them can very quickly understand and master these notions, vocabulary and functioning in order to start Get into the heart of the matter and start trading online on a real account.