What is Forex Exchange

Understand Forex Trading in Ten Steps

Lana Iliev, November 5th, 2020

Extremely high chances of winning! This is how forex trading beckons. But how exactly do the rich returns come about and what are the risks? We clarify the 10 most important questions about Forex trading.

1 | What is forex

The forex market is also known as currency or foreign exchange market, because forex stands for "Foreign Exchange". Forex trading therefore describes trading in foreign currencies. The foreign exchange market has two peculiarities: On the one hand, it is not a presence market because the market participants trade with one another through banks and brokers. On the other hand, profits can be made on the forex market even when other markets are in a low and prices tend to fall.

2 | How does Forex trading work?

On the forex market, currencies are traded whose values ​​are subject to fluctuations. Investors speculate that the value of a particular currency will rise or fall compared to another currency. The difference between the two currencies depending on the exchange rates, minus the payments to the broker and tax deductions, ultimately makes up the return (net) of the investor. Entry into forex trading is possible with a relatively small amount of money.

Forex & CFD: Forex trading has a number of similarities with CFDs (Contracts for Difference). However, the effect of the leverage compared to CFDs is many times higher.

Currency rates are mostly subject to minimal fluctuationswhich often only become noticeable in the area of ​​the fourth decimal place. For this reason, professional forex traders trade with us leveraged derivatives. In forex trading, after depositing a Security deposit (margin) provided additional capital for opening a position. The additional (borrowed) capital creates a leverage effect, through which even the most marginal fluctuations in the value of exchange rates can be exploited. The following is an example to illustrate this.

Forex trading example

They speculate that the dollar will lose value and the euro will appreciate by € 100,000 for $ 115,000 Buy at an exchange rate of € 1.00 to $ 1.15.
You don't have to give the broker the full dollar amount, you just deposit them Security deposit of for example 1 % (1.150 $).

Profitable scenarioLoss scenario
You sell the € 100,000 for $ 117,000, which equates to a profit of $ 2,000 (difference between buying and selling). They sell the € 100,000 for $ 113,000. You are making a loss of $ 2,000.
You get your margin ($ 1,150) back and an additional $ 2,000. Since your loss is greater than the deposited margin, you are obliged to make additional payments.
You have more than doubled your original bet of $ 1,150 and made a profit of + 173.91%. This means that you will not get your security deposit of $ 1,150 back and you will also have to pay $ 850 to make up for your loss.
In order to determine the net profit, you must also deduct individual brokerage costs and taxes. You also have to pay the brokerage fees, which continues to increase the loss.

3 | How do exchange rates arise?

The exchange rate (also foreign exchange rate or FX rate) determines the difference between profit and loss in Forex trading. But how does it come about? The actual rate determination of the currencies takes place on the interbank market. Just like other prices, changes in exchange rates arise from supply and demand. The more popular currencies are, the higher their value increases. Demand and supply are in turn influenced by political and economic developments and that is what makes the foreign exchange market extremely complexbecause it is influenced by a variety of factors.

First of all, the affects Economy individual states on the supply and demand of the foreign currency they issue. The purchasing power of a currency translates into Inflation and deflation low. National Central banks also try to influence economic developments. One example of this is the zero interest rate policy of the European Central Bank (ECB). If a central bank changes the key interest rate, this has a direct effect on the forex market.

There are also so-called Commodity currenciesthat are particularly sensitive to the price development of certain commodities. One example of this is the South African Rand (ZAR), which is related to the development of the gold price.
The exchange rate between currencies can also depend on whether the issuing country exports many products to other countries. Because Exports are always paid in the respective national currency, which is accordingly more frequently requested.

In addition there is many more political eventswhich can influence the development of foreign exchange. Much is unpredictable and, especially for the layman, opaque.

4 | What forex indicators are there?

There are a number of terms that are specifically used in Forex trading. You should know these here:

Base currencyThe currency that is being bought
Exchange rateThe currency that is being sold
LotInvestment size of the foreign exchange transaction: 1 lot corresponds to the purchase of 100,000 units of the base currency, a mini lot corresponds to 10,000 units and a micro lot corresponds to 1,000 units
pipA pip (price interest point or percentage in point) is the smallest possible price movement, usually in the range of four places behind the decimal point. Used to indicate price changes.
Smoothing outClose the position by exchanging the exchanged currency back.

5 | What are currency pairs?

Forex trading takes place with currency pairs (e.g. EUR / USD) and speculation is made on the price development of a selected currency pair. The first-mentioned currency sets the standard and is always one unit. For example, if the EUR / USD currency pair is specified as 1.15, this means € 1.00 is worth $ 1.15. The current rate (also known as the spot rate or spot rate) serves as the basis.

Usually one of the two currencies in a pair is the US dollar, as this is the most commonly traded on the foreign exchange market. Currency pairs that consist of two currencies other than the US dollar are called currency crosses.

The most commonly traded currency pairs are US Dollars and Euros (USD / EUR), Japanese Yen (USD / JPY), British Pounds (USD / GBP), Australian Dollars (USD / AUD), Canadian Dollars (USD / CAD) and Swiss Francs (USD / CHF).

6 | Where are foreign currencies traded?

Forex trading takes place mainly over the counter in so-called interbank trading, trading between individual banks and financial institutions (with the exception of central banks). Although there were foreign exchange exchanges in the past, these have largely been abolished, for example in Germany in 1998.

7 | Who trades in foreign exchange?

In the past, forex trading was mainly reserved for institutional investors. But now it is also of interest to many private investors. This is mainly due to the fact that both the Internet and online brokers simplify access to the foreign exchange market.

8 | When is foreign exchange traded?

Almost anytime. Due to the time difference, currency trading is possible 24 hours a day during the week. The stock exchanges only close on weekends. In Germany, however, you can trade continuously from Sunday evening to Friday evening. A lot is traded on weekdays between 1:00 p.m. and 5:00 p.m., because at this time the US and European markets are open at the same time. The constant availability of the Forex market contributed to making it one of the world's best-selling and most liquid at all.

9 | What are the advantages of Forex?

Forex trading offers investors a number of advantages. So it is initially possible to make profits even in a market environment that is characterized by falling prices. In addition, the leverage offers forex investors high liquidity, low minimum investment volume and in case of success high return opportunities. In addition, through the direct trade between the market participants arise flexible trading hours.

10 | What are the risks of forex trading?

However, in addition to the advantages, there are also a number of disadvantages to trading Forex. Because of the high risks, forex trading is also known as the “supreme discipline of trading”. First of all, the leverage can be enormous - it is not uncommon for the broker to borrow four hundred times the actual stake. Because of the considerable obligations to make additional payments, only limited orders should therefore be placed. In addition, you should only invest as much money as you can bear in the event of a loss.

The complexity of the foreign exchange market can also be fatal for investors. Exchange rate developments are often unpredictable and can be subject to extreme fluctuations within a very short period of time. As a consequence, forex traders are forced to keep an eye on their investments at all times, which makes forex trading extremely time-consuming.

In addition, the high fees for online brokers are detrimental to the investor. Either they reduce the return or they increase the loss. Seductive advertisements are used to encourage potential investors to invest in Forex trading. But because of the extremely great dangers, it is more for Suitable for institutional investors and very experienced and wealthy private investors.

Inexperienced investors should not engage in Forex trading. Anyone who is interested in getting to know how this trading instrument works in practice can contact most online brokers who offer forex trading Demo versions work without risk.

An alternative to Forex trading is crowd investing. Here, too, the investor benefits from a low minimum investment volume and also receives a fixed interest rate. At BERGFÜRST, for example, you can invest in investment opportunities from € 10, which give investors fixed interest rates of 5.0% to 7.0% per year. Since investors here come together as a “crowd” via an internet platform to invest in real estate, crowd investing is also very flexible. You can access the platform anytime, anywhere. With crowdinvesting there are no obligations to make additional contributions, no custody account costs and no price fluctuations.

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