The foreign exchange market or Forex currency trading has gained popularity in recent years. Investors engage in currency trades globally. The process of trading currency operates in a similar manner to trading stocks in the stock market. Currently, Forex currency trading is one of the fastest growing markets. The market experiences nearly a $3.98 trillion in transactions daily. This amount has increased 20% since 2007. The $3.98 trillion consists of $1.490 trillion in spot transactions, $475 billion in outright forwards, $1.765 trillion in foreign exchange swaps, $43 billion currency swaps and $207 billion in options and other products.
How Forex Works
Currency trading is preferred over stock trading for several reasons. The foreign exchange market is unique because of its huge trading volume and geographical dispersion. This leads to high liquidity. Trades may occur 24 hours daily Monday through Friday. Forex markets have lower profit margins compared to other fixed income markets. Leverage is used to enhance profit margins. Novice traders who do not fully understand complex forex trading principles may use software to automate trades.
Leverage
One of the primary advantages of forex trading is leverage. Leverage describes earning a profit on the money invested. The invested sum of money is called the “margin”. Margins are a deposit for the currencies traded during each transaction.
The higher the leverage ratio, the better the profit margin will be. Most traders may enter the market with as little as a $500 investment. Though the minimum investment is typically $500, for the sake of math and this example we will use a $100 investment. If your investment is $100 and there is a leverage ratio of 100 to 1, then your investment will be worth $10,000. An investment of $1000 will allow you to execute a $200,000 transaction with 0.5% leverage. Currency trading has the potential to be very lucrative; however, the losses may be large as well. A margin call indicates that 75% of your initial investment was lost.
Forex and Candlestick Charts
Candlestick charts provide a visual means to observe price fluctuations in a currency pair. Typically, a chart displays time on the horizontal or x-axis and the price on the vertical of y-axis. The time each candle represents depends upon how the chart is displayed. Investors selecting a one hour chart will view the price activity of the currency pair over one hour. Common chart time frames include one, five, 10, 15, 30, 60, four hour, daily, weekly and monthly charts.
The rectangular colored portion is the body of the candlestick. The lines on the top and bottom of the body are the upper and lower wicks. The length of the body or wick is dependent on the price range for the candle. Longer candles indicate more price movement from the opening time. The top of the candle wick indicates the highest price for the currency pair. The bottom of the wick indicates the lowest price. A bull market is indicated when the close of the candle is higher than the open. Candles without wicks indicate a bearish market. This signifies the closing price was lower than the opening price.