Earlier forex trading was done by hedge funds, high net-worth individuals (HNIs), investment banks or multinational corporations. With the advent of internet trading, retail investors can now participate in the currency market too. Due to its potential for higher returns and accessibility to global markets, it is a booming form of investment. Unlike the share market, the market for forex trading is open 24/7. Even though in principle it involves the trading of currency, it operates differently. In this article, we will go through some frequently asked questions (FAQs) about forex trading to help you understand it better.
What is forex trading?
Forex trading, also known as foreign exchange trading, involves buying and selling currencies in the international market. The basic principle is to profit from the fluctuations in currency exchange rates.
How does it work?
If you believe the value of the Indian rupee (INR) will appreciate against the US dollar (USD), you would buy INR and sell USD. If the INR does indeed increase in value, you can then sell it back to the market at a higher rate, thus making a profit.
You can also make profits from the difference between interest rates of two currencies. It is known as carry trade. To put it simple, carry trade is like short selling in the currency market. You buy the currency with the higher interest rate and short the currency with the lower interest rate
How is the currency market different than other markets?
Unlike the stock market, the currency market operates on a global scale for 24 hours a day and five days a week. It is not centralised and has no physical location. Instead, it is an over-the-counter market where participants trade currencies electronically. It is the most liquid financial market in the world. It involved buying and selling of currencies in large volume, with daily trading exceeding trillions of dollars. This high liquidity ensures that traders can enter and exit positions quickly, minimising the risk of price manipulation. Stock markets have centralised exchanges, on the other hand, currency market operates in a decentralised manner. It consists of a network of interconnected banks, financial institutions, brokers, and individual traders. This decentralisation eliminates the need for a central authority to facilitate trades.
What is leverage in forex trading?
Currency traders use leverage, that is, trading with borrowed funds. Leverage enables traders to control larger positions with a smaller amount of capital, potentially amplifying both profits and losses. For example, a leverage of 1:100 means that for every unit of capital, trader can control 100 units of a currency pair. While leverage can amplify profits, it also magnifies losses.
What is pip?
‘Pip’ stands for ‘percentage in point’ or ‘price interest point.’ It is a unit of measurement used to represent the smallest incremental price movement in a currency pair. Pips allow traders to measure and express currency fluctuations accurately. Most currency pairs are quoted with four decimal places, and a pip is typically represented by the fourth decimal place.
For example, if the EUR/ USD currency pair is trading at 1.1346 and it moves up to 1.1347, it means that the price has increased by one pip. Similarly, if the price moves down to 1.1345 it has decreased to one pip.
The value of a pip depends on the lot size or position size traded. The pip value can vary depending on the currency pair being traded and the currency in which your trading account is denominated. Different currency pairs have different pip values because the value of each pip is determined by the exchange between the two currencies.