FX or Forex Trading is the name given to trading one currency against another. When you go on holiday for example, you may sell your Sterling and buy Euros (if you are visiting Europe). For example you may find £500 will buy you EUR 600 at the bank or bureau de change on a given day. The next day you then find the exchange rate has moved and you can now buy more Euros in return for your pounds. This is the basic concept of FX trading – the constant changing of currency pairs at different exchange rates.
All Foreign Exchange rates are quoted in pairs. For example if we were selling Sterling (GBP) and buying Euros (EUR), this would be written in shorthand as GBPEUR. In this example GBP is referred to as the ‘base’ currency, and EUR is referred to as the ‘counter’ currency. The price at which this hypothetical trade of exchanging GBP for EUR can be carried out is called the ‘exchange rate’ between the two currencies.
Another factor to consider is the amount of currency you wish to buy or sell. In the world of FX trading, this is referred to as the ‘lot size’. One lot is the equivalent to 100,000 of the base currency. You can buy or sell in lots or in fractions of lots, for example mini lots and micro lots. This is a very important advantage of trading forex. This means you can control the amount of money you risk to speculate. It also means that you can speculate on a rise OR fall in a currency pair.
When you start trading currencies, or indeed any other CFD for that matter, you will see that the price quoted is actually a two-way price. For example, taking GBPUSD as an example, you may see the price is 1.5100 – 1.5102. The lower price (1.5100) is called the ‘Bid’ price or ‘Buy’ price, and the higher price (1.5102) is called the ‘Offer’ or ‘Ask’ price. This two way price is called a ‘quote’. This quote is what any price provider, who is also called a ‘market maker’, will give to you every time you request a price. The Bid price is the price at which the market maker will buy the currency, so is therefore the price you can sell at. While the Offer price is the price at which the market maker will sell the currency, so the price you can buy at.
One final advantage of FX trading is that you do not have to pay the full cost of the trade up front. Instead you only pay a small percentage of the cost up front. This cost is called ‘margin’. This is why this type of trading is called ‘leveraged’ trading – you only put down a small amount to control a much larger quantity of currency. For example, if you are trading on 1:100 leverage, this means you will typically pay 1% of the value of your trade as a deposit; thus freeing up your funds.
However, leverage can be a double edged sword. This is because the leverage not only helps you magnify any gains you may make but also magnifies the losses you can take relative to the amount you have deposited.