The financial market is divided into categories: stock market, metals, bonds, futures etc. But the most popular is the currency market – Forex (Foreign Exchange).
With daily volumes exceeding $5 trillion, FX is the largest and most liquid financial market, and not traded on any centralised exchange, allowing traders, brokers and banks to participate.
Now let's take a closer look at an example to help demonstrate the principle of making trades via an online CFD trading platform.
FX is priced and available to trade 24/5, covering all exchange opening hours.
The price of national currencies on the Forex market (for example, the US Dollar) reflects how the market perceives the current and future position of the national economy.
If positive news is published, currency quotes will generally start to rise, whereas news that is perceived to be negative, will generally cause prices to fall.
If you manage to open a ‘‘buy’’ trade via your online platform and wait until the price increases, you can make a profit, which will be added to your balance once the trade is closed.
In cases where the forecast is not right and the chart goes down, your trade will be closed in the red.
The currency pairs that you will see on your online trading platform display the value of one currency against another. It reflects the state of economies of the two respective nations.
On the Forex market, when placing a ‘’buy’’ order, you are buying one currency (first in the pair), and simultaneously selling the other (second one), and vice versa for ‘’sell’’.
Just like the exchange office at a bank, here you exchange euros for dollars (or other currencies).
Major currencies represent some of the world’s biggest economies; they’re the “majors” for exactly this reason.
Major FX Pairs are typically those that involve two Major global Currencies, such as EUR/USD, GBP/USD, USD/JPY, EUR/GBP, USD/CAD
Major currency pairs are very liquid, due to their popularity and therefore the cost of trading is lower than others (ie, Spread).
Other currency pairs can be categorised as ‘’Minors’’ or ‘‘Exotics‘’.
You can see the categorisation of each instrument through the platform specifications.
To understand this, look the example below (how many US dollars is received for 1euro):
EUR/USD = 1.07407
The price of EUR/USD shows that 1 EUR is equal to 1.07407 USD. This means that you need 1.07407 US dollars to buy 1 euro, or that you can get 1.07407 USD when you sell 1 EUR.
Euro, in this case, is the base currency (the price of which we want to determine), and the dollar is the term (quote) currency (in which the price is expressed).
You should always keep in mind that the base currency is the basis for buying or selling.
So, back to your trading platform:
- when you click ‘’Buy’’, you open a trade to buy (e.g. EUR/USD)
- when you click ‘’Close’’, you finish the trade (as if you are selling back EUR/USD, but on most CFD platforms you don’t need to trade in the opposite direction to close a position, you can simply use the ‘close’ function).
It turns out that each of your transactions is a link in an endless chain of purchases and sales. Someone sold to you - you bought. You closed the trade (sold the asset) - someone bought at that moment, and so on.
What is Bid/Ask and what is the difference between them?
Take another look at the market watch on your trading platform. You should see two columns, in which the quotes are constantly changing, highlighted in two colours.
E.g. for EUR/USD could be:
The ‘’Ask’’price is the price at which the broker is willing to sell, meaning the price at which traders Buy.
The ‘’Bid’’ price is the price at which the broker is willing to buy, meaning the price at which traders Sell.
So, when you open a buy position, it will be opened at the Ask price and closed at the Bid, whereas sell positions are opened at the Bid price and closed at the Ask price. This is where the ‘’Spread’’ comes in…
The difference between the Bid and Ask price is the spread, and this is what you pay to the broker to open a trade. (On some platforms a commission may also apply).
In an exchange office, you encounter the same thing: you are offered to sell the currency at one price and buy it at another, therefore you will always see two prices quoted for one pair.
The ‘’Ask’’ price is usually higher than the ‘’Bid’’, because it includes the Spread.
Spread in FX trading is quoted in pips, and can be fractional, for example, you may see a spread of 1.2pips. (We will discuss pips in a later lesson.)
So, when you open a trade, you will start with a negative unrealised PnL (profit and loss) until the chart covers the spread (the difference between the Bid and the Ask price). The tighter the spread, the more beneficial it is for the trader.