Currency trading is not the same as stocks, futures or bond options in that this does not take place on a fixed exchange. currency trading is not monitored by a central governing head, nor are there any clearing houses to guarantee trades. The trading is made by members relying on credit arrangements with each other. In a day, over USD 3 trillion worth of transactions is made, which only goes to show how extensive the Forex markets are, and why you should learn the currency trading basics.
An exchange rate is the ratio of one currency against the value of another. The first currency is called the base currency, and the second is called the counter or quote currency. The currency trading basics dictate that when buying, the exchange rate determines how much you should pay in the counter currency to buy one unit of the base currency. When selling, the exchange rate tells you how much you will receive in the counter currency units when you sell a single unit of the base currency.
To take an example, let us look at the trading pair of EUR/USD, with the Forex quote of 1.2435/1.2440. To trade, you can either buy 1 Euro Dollar with 1.2440 US Dollars or sell 1 Euro at 1.2435. The difference between the two currencies is called the spread. Currency trading basics about making mone yare very simple – you need to sell at a higher price than the one you’ve bought in.
In currency trading “pips” are used. A pip simply stands for Percentage In Point. Pips, which are sometimes called points and you may find it easier if you think of them that way. Currency trading basics state that pips are used to measure changes in the price of a currency pair. So you might see a report that EUR/USD fell by 10 pips this morning.
Why don’t they say it in dollars and cents? The reason is that not all forex trades involve the dollar, and even where they do, it may not be the quote currency. If your pair was EUR/JPY, you would not want to measure changes in dollars and cents. At the same time, it is clearly going to be confusing to have changes in each currency pair expressed in the different quote currencies. Therefore we use pips.
One pip is the smallest increment of the quote currency in any pair. In most cases, this means 0.0001 units of the quote currency. Again, currency trading basics state that the quote currency is the second one in the pair as it is normally written, so in the case of EUR/USD the quote currency is the dollar. This pair is usually quoted to four decimal places, e.g. 1.3875. If it falls to 1.3874, it has fallen one pip.
When trading currencies, currency trading basics state that you should always trade with the trend: If you take time to look at the chart regardless of what currency pair you are trading, you will find that price moves faster and higher in the direction of the trend and moves slower and lesser when it is against the trend. Therefore the chance of you making money against the trend is very low.
Also before trading currencies, you should always do pre-trade analysis. There is no way you are going to make money if you do not know the current situation of the currency pair you are trading. When you do pre-trade analysis for the trading pair, you will know the trend – i.e. whether the price is oversold or overbought. Currency trading basics tell us to always take note of major support and resistance levels, and With this information at hand, you will be able to set up your trading plan and then trade successfully.
Never trade When You do not have enough time. Currency trading requires time and attention to read the chart. If you do not have the time to go through the chart properly, you should not place a trade.
Always trade with a high risk/reward ratio. This is how the successful traders manage their trade – Again, currency trading basics state that you should always aim for a risk/reward ratio of at least 2:1.