How Does Forex Trading Work?
The big question on every new trader’s mind: How does Forex trading work?
Table of contents
Your quick guide to Forex trading in South Africa
Forex, or the foreign exchange market, is significantly different from stock trading. Therefore, these differences often make Forex look exotic comparing to the more familiar terms and techniques that we associate with the stock market. Despite the familiarity that the stock market enjoys, the Forex market is overwhelmingly the largest in the world. What is Forex trading, what makes this market so popular and how does Forex trading work?
How does Foreign Exchange Trading Work?
The Forex market is a global market for the trading of currencies. The fall of the gold standard happened in the 1970s. This led to most of the world currencies trading against each other on the global Forex market. So, if you feel that the Euro is going to rise against the British pound, you can make a trade reflecting that belief.
The performance of the economies that relate to each currency affect the values of currencies. The intervention of central banks in response to inflation, deflation or a sluggish economy also affect these currencies. Forex traders stay glued to economic reports like the CPI (Consumer Price Index) and hints of what the central banks will do about the interest rates.
Therefore, traders widely use economic calendars to stay on track of valuable financial reports from around the world.
In stocks and commodities markets, it can be frustrating when there is no upward price movement. Another good thing about the Forex market is that it’s much easier to “sell short” than it is in markets, such as the stock and commodities market – this is due to the nature of the Forex market, where trades always pit one currency against another currency. You are speculating that a currency will go up or down in value, against another currency.
What are Currency Pairs?
Currency pairs are the financial instruments, available to trade on the Forex market. These currency pairs represent the relationship between two currencies. For example, when EURUSD is 1.33, this represents that the Euro is worth 1.33 US dollars. To better understand quotes, read our article on; what is a Pip in Forex.
The base currency refers to the first currency in a currency pair, while the quote currency refers to the latter. The quote of a currency pair represents how much of the quote currency corresponds to one unit of the base currency.
The most heavily traded Forex pair is, by far, the EURUSD. This pair constitutes nearly a quarter of all Forex trading.
The major pairs, or majors for short, refer to the seven most heavily traded currency pairs in the Forex market. Every one of these pairs has the US dollar (USD) as a component. The major pairs are Euro/US dollar (EURUSD), US dollar/Japanese Yen (USDJPY), British pound/US dollar (GBPUSD), Australian dollar/US dollar (AUDUSD), US dollar/Swiss franc (USDCHF), New Zealand dollar/US dollar (NZDUSD) and US dollar/Canadian dollar (USDCAD).
What is Margin Trading?
Another distinguishing feature of Forex trading is its widespread use of margin. Leverage is a type of credit that is given to you by your Forex broker. You must put up a collateral amount, known as margin, to qualify for the leverage – this is how margin and leverage work together. Margin and leverage are two terms that the Forex community often use interchangeably, but they are slightly different even though they relate to one another.
Ratios like 1:100, 1:200 or 1:500 express the amount of leverage involved. Read this article to learn what margin is and how to calculate it.
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Margin and leverage allow you to multiply your potential profits greatly. If you are using a leverage of 1:20, that means that you can increase your capital by 20 times your deposit. However, just as using leverage greatly multiplies the gains you might receive, it also multiplies the losses you could encounter. Should you lose enough in any open trades, where your equity is not sufficient enough, you may receive what is known as a margin call.
This automatically closes your trades because the collateral that you used to back the leverage is gone.
That’s why it’s important to use leverage wisely and don’t abuse it. The potential for abusing leverage is one of the reasons why it is generally tough to obtain margin accounts in stock and other trading markets. Margin trading is a much more widely accepted part of Forex trading.
Getting Started with Forex
The best way to start Forex trading is to study it and learn as much as you can. If you want to get your hands dirty with it, do so with a demo account.
Never rush into live trading without proper education and experience. There are many books and resources on the Internet to help explain how to start Forex trading.
Forex Brokers in South Africa
Just as in much of the rest of the world, Forex trading is gaining popularity in South Africa. Brokers located in South Africa must abide by the regulatory demands of the Financial Sector Conduct Authority (FSCA). Such requirements include having a certain amount of capital on hand, a cap on the amount of leverage provided to traders and a mechanism for the redress of grievances.
Other brokers from around the world also cater to traders in SA. They must abide by similar requirements by other regulatory agencies such as the Australian Securities and Investments Commission (ASIC) and the Financial Conduct Authority (FCA) of the UK.
Final Thoughts on How does Forex Trading Work
Forex trading is a global market that has exciting and significant differences from national stock and commodities markets. Instead of companies or commodities, you are trading currencies against each other. These currencies pitted against each other are called currency pairs—and these are what you buy and sell in the Forex market.
Margin trading in the Forex market is much more accessible than it is in stock and commodities trading, giving you fantastic profit potential if you use it wisely. Forex trading is always gaining popularity in South Africa, just as it is in most parts of the world.
Our Forex brokers in South Africa page has information about brokers that welcome SA clients.
Heinrich is a forex and CFD enthusiast with a passion for writing good informative quality content. He strives to showcase the best forex brokers in Africa. Join him on his Journey!
Content Writer | Market Analyst
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