This first part of this lesson gives introduction to the forex market, and the mechanics of trading. The next part of this lesson explains about the different types of market participants and their motivations. You need to know this to understand some of the factors that influence the market.
Introduction to Forex Trading
The foreign exchange (or FX) market is the largest financial market in the world, with daily turnover of over $1 trillion.
The FX market is an unofficial decentralised market so there is no central exchange as there is for common stocks or futures. Prices are set by agreement between buyers and sellers. This means that FX prices may vary between different points at a particular time – there is no official quoted price. In practice, if prices get out of alignment, traders called arbitrageurs quickly step in to profit from any short term discrepancies, and this means that prices tend to be about the same regardless of geographical location.
About Currency Trading
The major currencies traded in the FX markets are the Euro, US dollar, Japanese yen, Swiss franc, Canadian dollar, Australian dollar and New Zealand dollar. Other currencies are available, but are not traded often and this means that the cost of trading them is much higher, so FX traders generally focus on the most popular currencies.
FX transactions are always between two currencies, which are called currency pairs. For example, a common pair is EUR/USD. When someone buys this, it means that they are buying Euros and selling US dollars.
Prices are moved by differences in supply and demand within an FX market. If there is a high demand to buy a currency, but a low supply of the currency (holders unwilling to sell), then prices will move up. If more holders wish to sell a currency than buyers wish to purchase, then prices move down. Supply and demand are influenced by the expectations of forex traders – that is, their view of where the currency price will move to in the future.
Forex contract sizes
The usual contract size for ordinary FX traders is USD $100,000. This is one lot, which is the minimum size normally traded. You put up a margin, usually $1000-$2000 depending on your broker.
Some FX brokers now offer mini-contracts. These are 1/10 the size of regular FX contracts, and represent $10,000. The margin is proportionately smaller. The cost of trading mini-contracts is higher, as there is more work for the broker to do in fitting the mini-contracts into the market. However mini-contracts are a great opportunity to start trading without having to risk a lot of money, and can help new traders become familiar with the market before moving on to the full size contracts.
Forex Trading Indicators
Many Currency traders use indicators like relative strength index (RSI), moving averages, stochastics as part as FX trading system.