Back to basics: a forex primer

While on the surface, forex trading shares many similarities to other forms of trading, it has its own language and fundamentals that every trader needs to understand before setting out. This is your primer on the absolute basics you need to know.

FOREX, or the foreign exchange market, is a marketplace that offers trading of currencies against each other. All the foreign currencies that exchange during a day are counted towards the daily turnover and includes all trades made between individuals, banks, brokers, market makers, etc. The foreign exchange market is the largest market in the world with a trading volume of approximately $4 trillion each day.

The market itself is not hard to learn. Like stocks, you are selling and buying a currency at certain rates. If you buy currency when it's low and sell when it is high, you make money. Like all forms of trading, the trick is to know when it is the right time to buy.

But even before that stage, there are some basics of forex that any trader needs to understand. This is your primer of the basic terms and concepts of forex trading.

Market Hours

Five days a week, the forex market is open 24 hours a day. During the trading week, there is no worry about when the markets will open. At any point, at least one of the world's four trading sessions is underway. These sessions are based around four of the world's leading trading centres: New York, London, Tokyo and Sydney. The best trading occurs when two sessions overlap, while later in the week, Wednesday to Friday, are the busiest trading days. The weekends are market holidays and all trading activity stops until the open of the Tokyo session on Monday.

Leverage

This is an appealing part of the forex market, with most dealers offering leverage in trading. Leverage is something that allows dealers to multiply their investment to make a larger profit. However, it is also important to remember that with the chance of greater reward, leveraged trading can also bring greater risk.

Currency Pairs

These describe the two currencies being traded against each other, with each currency being assigned a three letter abbreviation. The first two letters are the country, the last indicating the currency (ie. With USD, US is obviously United States and D is for dollar).

The major currency pairs, based on the volume traded, are typically: EUR/USD, USD/JPY, GPB/USD, USD/CHF, USD/CAD, AUD/USD, NZD/USD

There are also major cross-currency and minor currency pairs, that is currency pairs that do not include USD, such as Euro crosses, Yen crosses, as well as others.

There are also exotic currency pairs. These pairs are made up of one major currency paired with an emerging economy's currency, such as Mexico or Hungary.

Electronic Communication Networks (ECN)

Electronic Communication Networks (ECN) is the name set for the trading platforms that match their customers' buy/sell orders at stated prices. Orders made through an ECN are passed into the open market. ECN brokers usually charge a smaller commission than other brokers on each trade the customer takes.

Market Makers

A market maker can be a bank or a brokerage firm that offers to buy or sell you currency even though they don't have a buyer/seller lined up. The market maker has a set ask and bid price and when they sell or buy currencies, they are actually "making a market". However, you can never be sure if your order gets passed through to the open market. Market makers do not offer their services for free but take a spread on each transaction. This spread may not look like much on one transaction, but considering the $4 trillion daily trading volume, they are able to get a significant take on their small spreads.

These are just some of the absolute basics to understand before getting into the world of forex trading. There are a wealth of resources available to help further develop your understanding, as well as information on our blog and future issues of Forex Currents. (And if you are new to forex trading, there is no better way to learn than by doing. You can always sign up for a free demo account to simulate live trading and get your feet wet without any risk.)