What is Forex?
Forex, foreign exchange market is a global decentralized market for the trading of currencies. Putting this into explainable terms, forex is a worldwide market for companies or individuals to trade currencies without a centralized location.
The first reason being forex doesn’t require a big capital.
Stock markets in Malaysia require you to buy at least a 100 shares which could be a hefty cost at the start. However as a young adult only with a small amount of savings, the stock market might be too costly to go into. Instead, young adult can set their eyes upon the forex market because the only minimum requirement a forex broker would require from you is merely a 100 USD.
Secondly, in forex you can see your gain/losses much quicker than in stocks or real estate markets.
If you play your cards right, your investment should provide more wins than losses most of the time. Don’t believe us? Continue reading to find out why!
How does Forex work?
In a typical forex market, you will earn a profit through buying currency when it is low and selling when it is high. The basic concept itself is very similar to any other product, however please do not forget that currency is relative. When you say that a currency is growing stronger, it normally only holds true against a few foreign currencies. For example; to say that the concept of “buying” a currency on the basis that its value will rise in the future makes no sense because a currency’s value is relative to others.
Using our neighbour Singapore as an example, when looking at SGD to MYR exchange rate,
SGD seems to be doing really well against MYR as of recent years. However, when looking at SGD to USD
The growth of SGD pales in comparison with USD, even showing a downward trend when it was clearly appreciating against MYR.
In summary, there is no absolute to be drawn about whether or not that currency value by itself has gone up because a currency value is always dependant on another currency.
When trading in forex, you are trading currencies in pairs because this way you can make a direct comparison between the value of both currencies. For example, one of the most common trading currency pair USD/EURO.
How does a currency pair work?
The 1st currency pair will always be the base currency while the 2nd currency pair will be the quote currency.
An easy way to remember is buying and selling a currency pair will always affect the FIRST currency directly. When you are selling a currency pair, you are selling the 1st currency (base currency) and when you are buying a currency pair, you are buying the 1st currency (base currency) .
Always remember that the key question when trying to understand a currency pair is how much of the 2nd currency Pair (quote currency) is needed to trade for one 1st currency pair (base currency) ?
The answer is given by the value of the currency pair, 0.8924. In summary,0.8924 EUR is needed to trade for 1 USD.
Currency pairs can easily be inverted by inverting the exchange rate, however due to the popularity of the US dollar most platforms will quote USD as the base currency. In this case, EURO/USD exchange rate would be 1.12056. Most trading platforms will only offer one variation of a currency pair because there is really no difference between them.
Of course, when trading in a forex market, brokers are required to carry out the deal.There is always the fear of dealing with a dishonest dealer, learn more about these online scam and only trade with legal and trustworthy brokers who are from reputable companies
Due to the involvement of brokers, the price you pay includes a commission to the broker which is commonly known as spreads. The exchange rate is usually very close but NOT equal to the actual buy and sell price.
For example when the exchange rate of USD/EURO is 0.8982, the currency pair real buy and ask price will be shown in terms of bid and ask price.
When looking at a bid ask price, remember that you are looking at it from a broker’s perspective. A bid price is a broker’s offer price which means the price broker offers to buy . The Ask price is the price which the broker ask from you which means the price the broker offers to sell. This works to the broker’s favor because just by buying and selling, the broker can earn 0.002 USD per unit. However, the bid-ask spread does not necessarily work in your favor because if you have bought a currency pair, you are buying at the “Ask” Price and you will have to wait for the bid price to exceed the ask price to earn a profit. In this case, You have to wait for the bid price to grow by 0.002 before making a profit. In short, the bigger the spread is the bigger the increase you will need to earn a profit.
How do you actually earn from the forex market?
Let’s say you started back on June 1st with 1000 USD in your bank account. You predict that USD currency will drop against the Euro currency. If your trading platform has given you access to a currency pair USD/EUR, what should you do? Simple, just remember a key quote, “buy when it’s low, sell when it’s high”. So you would sell the currency pair USD/EUR because it will drop in price.
And this is how things turns out to be….
If you had held on to the currency for 1 month, the highlighted part would be your profit. Putting it into numbers
A 17.56 USD profit in one month doesn’t sound that impressive at all. However, it should not come as a shock too because of two reasons. The first one being the we did not buy back the currency pair at it’s lowest point and the second reason being that the currency movement is small in general.
To be Continued: Part 2
But wait a minute… I have seen my friends earn thousand of USD through forex, it makes no sense that I can only earn 17.56 USD right? Well, there are two reason for this, the first one could be that they had a much larger capital than 1000 USD. But as you can see, the return on investment from above the calculation is only 1.8%. If I wanted to make 1000 USD PROFIT, It would have required 55,555.55 USD in capital which would be a too large amount for someone like myself.
The second reason is by using leverage.. If you wish to know more about leverage and what are the ways to limit your risk and losses in forex, check out part 2 of this article coming soon!