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Forex Trading How to Trade Forex (Beginners Guide)
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Learn to trade shares. Learn to trade CFDs. The mechanics of a trade are very similar to those found in other financial markets like the stock market , so if you have any experience in trading, you should be able to pick it up pretty quickly. The objective of forex trading is to exchange one currency for another in the expectation that the price will change. More specifically, that the currency you bought will increase in value compared to the one you sold.
An exchange rate is simply the ratio of one currency valued against another currency.
3 Things I Wish I Knew When I Started Trading Forex
The reason they are quoted in pairs is that, in every foreign exchange transaction, you are simultaneously buying one currency and selling another. Whenever you have an open position in forex trading, you are exchanging one currency for another. The base currency is the reference elemen t for the exchange rate of the currency pair.
It always has a value of one. The second listed currency on the right is called the counter or quote currency in this example, the U. When buying, the exchange rate tells you how much you have to pay in units of the quote currency to buy ONE unit of the base currency. In the example above, you have to pay 1.
What is forex trading?
Scroll to the bottom of the post for link to a Complete Whiteboard Explainer Video. So price setting is done behind closed doors. They are also referred to as dealers. These intermarket trades are very important as they help inform dealers about what prices to set for their customers.
Dealers have an advantage in that through the orders that arrive at their desks, they have a lot of information at their disposal which can help them understand the outlook of their clients. Many of these clients are very well informed. Well get more into the importance of the access to this information later. So the dealers D make trades on the interdealer market but they also interact with non-dealer customers.
They can interact directly with clients C and with other banks B which also have their own clients. They can interact directly with Prime Brokers PB , who have clients as well. And finally they also interact directly with Retail Aggregators RA and this is where you and your broker come into the picture. Just as the name implies, Retail aggregators bundle retail trades into larger trades which can be then handled by the dealing banks.
Chapter 3. Why Forex is or isn’t For You
These are your brokers and there are different approaches of how they handle the trades of their clients. One method is that they and pass trades directly through to their dealers or whatever liquidity feed they are connected to.
They essentially match the orders of their clients with their liquidity providers and pass the orders directly through the system. They are referred to as non-dealing desks because they are not making the market by taking the other side of the trade but only passing trades through the system as a middle man. Other brokers may use the ECN model but also act as dealers to the retail clients in that they may match your trade with their internal inventory.
How do currency markets work?
So what they are doing is that they are offsetting your trade with another one of their clients or they themselves may even act as the counterparty to your trade. Clearly, if your dealer is on the other side of your trade they would have an agenda for you to lose which is somewhat disturbing. These circumstances bring in the temptation to knock you out of your trade through what is often referred to as stop loss hunting. These types of brokers are referred to as dealing desks as they are acting as dealers to their internal clients opposed to passing the trades straight through to a liquidity provider as the non-dealing desk does.
Those are the main differences between broker systems and you can now quickly understand the pros and cons of each type. Typically the brokers that also act as dealers have fixed spreads. Because they internalize a lot of the transactions they can set the spreads to a fixed rate higher than what their liquidity providers offer them.
So this mark-up on spread gives them a bit of profit and it gives you some certainty of what you pay for each transaction. Because non-dealing desks pass your trades straight through to their liquidity providers you get the advantage of a very tight spread — so you get a better rate. Yet the flip side is that these dealers have no control of the spreads so you are also subject to any type of volatility or widening spreads that might happen during lower liquidity sessions.
With a dealing desk brokerage you are sheltered from this normal market behaviour through their fixed spreads; however, there is also the unsettling risk of your broker being on the other side of your trade and their motivation for you to lose. Whether they act on those opportunities or not certainly depends on the integrity and reputation of your broker.
Okay, so those are the players in the forex market structure.