Let’s take an example, a buy order on AUD/USD means buying AUD and selling USD at the same time.

In simple terms, by opening a buy position on AUD/USD, the trader is buying AUD by paying USD in return.

In this case, the trader will earn a profit if AUD gains in value against USD or USD loses its value in terms of AUD. If a position is closed, the AUD will be sold back at the prevailing conversion rate of AUD/USD and the trader will receive the converted USD in return.

Forex is the largest capital market in terms of daily trading volume. Unlike stock markets, the forex market is active throughout the day. The liquidity of the traded currency pair depends on the time zone in the local jurisdiction of concerning currencies.

For example, when the liquidity on USD/CAD is high, it will not be the same on AUD/JPY due to different time zones.

Lower liquidity means lesser trading activity on the concerned pair and the difference between buy and sell rates (spreads) will increase dramatically during this period.

Forex Trading can also be done by exchanging physical currencies. However, through derivatives like futures contracts and CFDs, forex trading has become more accessible for retail traders. But at the same point, it is risky for retail traders.

CFDs on Forex do not involve physical buying and selling of currencies but the price difference is paid out or debited from the traders.

In Australia, several financial services providers offer Forex Trading on leverage.
Leverage allows traders to open bigger positions with smaller deposits. The risk factor increases with the increase in leverage.

Apart from market risk, there is also a counterparty risk or third-party risk of choosing a fake broker. To mitigate this risk, Australian traders must always choose a broker that is licensed/authorized by the Australian Securities and Exchange Commission (ASIC), which can be verified from the ASIC Connect’s Public Register.

3 ways to trade forex

There are three main ways to trade in foreign exchange: spot, forward, and future.

Spot market

The spot market is also known as the ‘cash market,’ where currencies are bought and sold and delivered on the spot. The price of a currency in the spot market is determined by demand and supply. That means the more the demand for a currency higher the value of that currency.

However, it’s not that simple. Some countries intentionally keep the currency values low to make export cheaper or attract foreign investments. The currency value is calculated on many factors, such as interest rate, market sentiment, political change, and economic news.

The final deal between one party that sells an agreed-upon currency price and the other that buys that agreed-upon exchange rate is known as a ‘spot deal.’ Once you close the position, you receive the specified amount of that currency in cash. Although the spot deal is considered spontaneous, the cash settlement usually takes two days.

Forward market

A private agreement between the two parties to buy a currency at a future date and the pre-agreed price is a forward contract. Let’s take an example to understand how a forward contract works.

Assume that a UK car company wants to secure a contract for a future purchase of spare parts from X, which is located in the US. The UK company signs an agreement with the US company to buy the spare parts after six months.

Both agree for a future exchange rate of 1 GBP = 1.3700 USD, and at the time of the agreement, 1 GBP is equal to USD 1.3700. Now suppose, after six months, the value of one dollar drops to 1.3800. That means the importer will benefit by USD 0.01 per unit of the exchanged currency. Now reverse the situation, the price of one dollar increases to 1.36.

In this case, company X (exporter) will benefit from the forward contract to hedge their risk. The vital thing to note is that currency value can move in any direction, either up or down. Who benefits from a forward contract depends upon the value of one currency against the other after six months.

Future market

A future agreement is similar to a forward contract; the only difference is that the latter is a standardized contract. The futures contract is a standard contract that specifies the quantity of a particular asset at a pre-determined price and delivery date.

For example, suppose Indian Oil signs a future contract to import 1 million barrels of oil with an oil producer based in Saudi Arabia. The oil producer promises to deliver the specified quantity in twelve months at a pre-agreed price of $75 per barrel.

So even when the price of one barrel falls to $70, the importer is obligated to pay the premium. The same is true when the price reaches $80; the oil producer will deliver the quantity despite the changes in the spot price.

There are several terminologies associated with forex trading. Acknowledging these terms is important to understand the working of forex trading.

1) Currency Pair: Forex trading is done on currency pairs in which two currencies are involved separated by ‘/’. The currency above or before the / is called base currency that is bought or sold in opening a position. The currency after or below the / is called quote currency which is used to buy and sell the base currency. For example, AUD/USD is a currency pair in which AUD is the base currency and USD is a quote currency.

2) Bid Price: Each time you see the price of a currency pair, there will be two prices. The price that the dealer is willing to pay if you sell the currency pair is called the bid price. The bid price is lower than the ask price and is generally mentioned before the ask price.

3) Ask Price: The ask price is the price that you will pay or the price dealer is willing to accept if you buy the base currency. The ask price or buy price is slightly higher than the bid price.

For example, the price of AUD/USD will be denoted as 0.7287/ 0.7291. In this example 0.7287 is the bid price in USD at which the dealer is willing to sell 1 unit of AUD. 0.7291 is the ask price in USD at which the dealer will buy 1 unit of AUD.

4) Spread: In the above example, you can see the slight difference in the bid and ask price of the currency pair. This difference between the bid and ask price is called the spread. It is a type of fee that is paid to the dealer for creating and accommodating the market. Higher spreads mean more earnings for the dealer and lesser gains for the trader and vice versa.

If the spread is 0, the bid and ask prices are equal. The spreads are generally denoted as the fourth decimal point in a currency pair. If AUD/USD is trading at 0.7287/ 0.7291, the spread is 0.0040 or 40 pips.

5) Pips: Pip or percentage in points is the smallest unit at which the prices of a currency pair can fluctuate. Most of the currency pairs fluctuate by four decimal places as the smallest change. If AUD/USD is trading at 0.7287/ 0.7291, then the smallest movement possible will be 0.0001 or 1 pip.

6) Lots: Forex trading is done in fixed lot sizes. A standard lot of a currency pair involves 1,00,000 units of the base currency. Generally, the minimum lot size that can be traded is 0.01 lot or 1000 units of the base currency. 1000 units of the base currency are also called a micro lot.

7) Leverage: Forex trading is commonly done with leverage. Since there is a very small price movement, leverage plays an important role to book higher profits with smaller deposits. Leverage is the fund borrowed from the dealer to open any position in forex trading.

If a broker offers a leverage ratio of 1:100 on forex, it means that 99% of the amount in the opened position is leveraged or loaned from the broker. Bigger positions can be opened with leverage with a smaller deposit amount. Excessive leverage increases the risk factor as losses are to be covered by the trader.

8) Margin: It is the amount that the trader is required to pay to open a certain position in forex trading. Suppose if 1:100 is the leverage ratio then 1% of the overall cost of the position has to be paid by the trader initially. Any opened position in forex trading is worth margin amount + leverage amount.

9) Buy/Sell Order: Each currency pair can either be bought or sold. If a trader has placed a buy order, he would want the price of the base currency to increase and the quote currency to decrease. This is commonly called a long position in forex trading. In a short position, the trader has sold the base currency and will gain if the price of the base currency decreases. Going long as well as short is quite convenient in forex and CFD trading compared to other asset classes.

10) Stop Loss/Take Profit: These are the type of limit orders which can greatly assist in forex and CFD trading. The stop-loss feature allows traders to limit losses or protect their profits. The take-profit features allow traders to automatically take the profits if a target is achieved. If the set stops loss or take profit target price is triggered, the position is closed automatically. Stop loss and take profits can be set while placing the order and can also be placed or modified after opening the position.

11) Support and Resistance: Support and resistance are quite popular indicators in technical analysis. The support and resistance are the specific prices of a financial instrument that are likely to reverse the course of price trends. Support is the lower point or bottom while resistance is the upper level or ceiling. Falling prices are likely to halt or increase after reaching the support level. Rising pricing will stop moving upward after reaching the resistance.

Market Trading Terms

Some terminologies are based on market activities and traders must acknowledge these to understand price movements in the forex market.

1. Bull Market

Bullish trend or bullish market is a commonly used term in financial markets to denote appreciation in the price of the asset. For example, a continuous rise in prices of a commodity or stock for a prolonged period will be called a bullish trend.

In a forex pair, a bullish trend can be due to appreciation as well as the depreciation of one currency with respect to other. For example, a bullish trend in EUR/USD currency pair represents an appreciation of the EUR and/or depreciation of the USD.

2. Bear Market

A bearish trend or bearish market is exactly the opposite of a bullish trend. Continuous depreciation in the price of an asset is commonly denoted as a bearish trend.

In the forex market, appreciation of quote currency and/or depreciation of base currency can be called a bearish trend on a currency pair.

3. GDP

GDP or Gross Domestic Product is the total value of all the goods and services produced in a country in a particular time period. It is a popular indicator that represents the overall health of a nation’s economy.

Growth in GDP can be compared with other nations to predict the increase or decrease in the price of a currency pair. For example, in a hypothetical currency pair ABC/XYZ, the GDP of the country with ABC currency increases more than the GDP of XYZ nation. This means ABC is growing faster than XYZ and the price of ABC in terms of XYZ is very likely to increase.

4. Inflation

Inflation means a rise in prices in a nation over a time period. There are multiple factors in an economy that can increase or reduce inflation. Each country has different inflation rates at a particular time interval.

The inflation rates of two currencies involved in a currency pair can be compared to predict the price movement of a currency pair. The country with a higher rate of inflation will lose its value against the one that has a lower inflation rate.

5. Interest Rates

The interest rate of a country that is also known as the repo rate is the basic rate at which the central bank will provide loans in a particular nation to commercial banks. Interest rates also depict the rate at which investors can earn through fixed deposits in the country.

Interest rates are decided by the central bank or the monetary authority of a nation. Interest rates can be comprehended to predict the price movements in a currency pair.

Forex trading can best be learned with experience. It is a high-risk market and traders must use demo trading where they can gain experience with virtual currencies. It is a high-risk capital market and is not ideal for every type of trader. One must check the suitability, objective, and risk elements thoroughly before entering the forex market.

Latest Development and Technological advancement in Forex Trading

The latest developments and technological trends in Forex trading with the use of AI as of 2024 are quite groundbreaking. Here’s an overview of the key advancements:

Automated Trading Systems and AI Traders: AI-driven automated trading systems have become more prevalent, accounting for a significant portion of forex transactions. These systems are capable of analyzing large datasets rapidly, identifying market trends and executing trades with remarkable speed and efficiency. This has led to the emergence of autonomous AI traders, which can react to market changes and news events almost instantaneously, providing an edge over traditional human traders.

AI-Driven Market Sentiment Analysis: The use of Natural Language Processing (NLP) and machine learning algorithms in sentiment analysis has become a critical tool. By analyzing news articles, social media, and online content, AI can gauge public sentiment towards different currencies, offering traders valuable insights for making more informed decisions.

Virtual and Augmented Reality in Trading: The integration of AI with Virtual Reality (VR) and Augmented Reality (AR) technologies is reshaping the trading experience. This includes immersive environments with interactive forex data visualizations, AI-generated alerts in AR overlays, realistic forex training simulations, and collaboration in virtual spaces.

Real-Time Big Data Processing: The ability to process and analyze large datasets in real-time has become crucial. Big Data technologies enable traders to stay updated with the latest market movements and news, allowing them to make quicker and more informed decisions.

Hyper-Accurate Forex Analysis and Predictive Analytics: Advanced machine learning techniques are transforming forex analysis, making it possible to predict price movements with higher accuracy. Predictive analytics using historical data and statistical algorithms are providing traders the ability to anticipate market trends and currency fluctuations more accurately.

Democratized Access for Retail Traders: AI and Big Data are leveling the playing field for retail traders by providing access to advanced analytics and trading signals. Online forex brokers are offering AI tools that can analyze charts, market news, and identify trading opportunities.

Automated Risk Management: AI systems are capable of conducting rapid automated risk analyses, including real-time evaluation of risk exposures and volatility modeling. This enhances safer trading practices.

Increased Transparency and Regulation: With the rise of AI and automation, forex markets are facing stricter regulations for transparency and control over autonomous systems.

Personalized Trading Experience: AI algorithms are enabling a more personalized trading experience by learning from each trader’s behavior and preferences, offering tailored trading advice and strategies.

Growth of Social Copy Trading: Social trading platforms are being enhanced by AI, enabling smarter trader selection, dynamic copy trading, and predictive analytics for better trade filtering.

Always-Learning Algorithms: Self-improving AI algorithms are on the horizon, which will continually adapt and optimize trading strategies, making real-time adjustments to market changes.

These advancements are transforming the Forex trading landscape, making it more efficient, accurate, and accessible. The integration of AI in Forex trading is not just enhancing existing methodologies but also creating new opportunities and paradigms for traders at all levels.

Let us understand the complete process and working methodology of the forex market with the help of an example.

Online forex trading is done through a trading platform which is software that can be downloaded on electronic devices. The trading platform connects traders to brokers, liquidity providers, and other forex traders.

Traders place to buy or sell orders through trading platforms on their preferred trading instruments. The exposure and profit/loss depending on the volume traded and the leverage involved.

Leverage of 1:10 will allow you to open a position worth $100 exposure with $10 in your trading account.

In this example, we will take the leverage of 1:10 on EUR/USD currency pair. The supposed market price for EUR/USD is 1.2100/1.2102. This means that the bid price is 1.2100 (the price that the dealer is willing to pay) and the ask price is 1.2102 (the price at which the dealer is willing to buy) and the spread is 2 pips (difference between the bid and ask price at 4th decimal).

First, we will place a buy order for 1 standard lot (100,000 units of the base currency). To place a buy order of 1 standard lot on EUR/USD, the following will be the calculation of the required account balance.

$1.2102 * 100,000 * 1/10 = $12,102
(ask price) * (units of base currency) * (leverage ratio) = (minimum account balance required to open the given position)

Now suppose the price of EUR/USD went up by 100 pips and reaches 1.2200/1.2202. By closing the buy position at this price, the following will be the profit.

(1.2200 * 100,000 * 1/10) – $12,102 = $12,200 – $12,102 = $98
(bid price * units of base currency * leverage ratio) – (exposure) = Profit/Loss

Now let us understand the same scenario with a short position on EUR/USD with 1 standard lot at the current market price of 1.2100/1.2102. Following will be the exposure amount in a short position.

$1.2100 * 100,000 * 1/10 = $12,100
(bid price) * (units of the base currency) * (leverage ratio) = (minimum account balance required to open the given position)

Now suppose the price of EUR/USD went down by 150 pips and reaches 1.1950/1.1952. By closing the position at this position, the following will be the profit.

$12,100 – $(1.1952 * 100,000 * 1/10) = $12,100 – $11,952 = $148
exposure – (ask price * units of base currency * leverage ratio) = profit

It must be noted the exposure amount ($12,102 in the long position example and $12,100 in the short position example) will be at risk of capital markets. If the leverage is high, the profit/loss amount will move more with the change in the pip value of the underlying asset.

1. Unregulated Broker risk:

Online forex trading has attracted thousands of retail investors in Australia. Trading with a trusted and well-regulated broker ensures your funds are in safe hands. If something goes wrong, there is a security mechanism that comes into play to protect your investments.

National, as well as major Tier-1 Forex Broker regulators, ensure that brokers offer fair and transparent trading environments. They set standard criteria and reporting requirements for a forex dealer before providing services to its clients. They also continue to monitor brokers’ trading practices and in case of wrongdoing, the financial regulator can cancel the broker’s license.

Before choosing, ensure that your broker is well-regulated and trustworthy. Don’t get persuaded by Pyramid schemes or fake agents offering unbelievable and unrealistic returns. There are plenty of examples of when retail investors lost their money to fake brokers and Ponzi schemes.

The best way to avoid this risk is by selecting a broker having Tier I or Tier II licenses. Tier I indicates the highest level of trust, and Tier II has a low level of confidence. UK, European, American, Australian, and Canadian regulators score well on their trust level and are called Tier I regulators.

Traders based in Australia must only trade with forex brokers that are regulated with ASIC. You must check the products for which the forex broker/firm has been Authorised, and verify the Firm’s Reference No. and their website from FCA’s Register. Only this will ensure that you are trading with an authorized firm.

2) Market Risk

This is the risk of extraordinary price swings in currency pairs. Forex is a complicated market as the price movement depends on countless factors. It is active throughout the day and any event across the globe can have an impact on price movements. It is nearly impossible to correctly predict price movements. Research and analysis can greatly enhance the success rates but market risk will always prevail in the forex market.

3) Leverage Risk

The leverage allows traders to open bigger positions with smaller margin requirements. High leverage can help in booking higher profits in case of favourable outcomes. The extent of profits, as well as losses, depends on the size of the opened position. The bigger positions can provide dramatic losses and can also wipe out your account balance completely if a position is not closed.

Beginners should not involve too much leverage in trading forex in the initial phase. Leverage of more than 1:10 is considered risky. The Australian Securities and Exchange Commission (ASIC) has restricted the maximum leverage that CFD brokers can offer to 1:30 for major forex pairs. The maximum leverage is lesser for CFDs on indices and commodities to protect the traders from high leverage risk. Although, clients can increase their leverage if they fulfil the ASIC criteria to become a professional trader.

4) Technical Glitches

Forex trading is mostly done online through trading platforms on mobile, tablets, and PC. A technical glitch can disrupt the trading experience. Traders can miss out on trading opportunities due to slow internet or processor issues.
The timing to open or close a position can vary due to technical problems. Accounts can be hacked. The account credentials and passwords must be protected. Public wi-fi networks must be avoided. Fingerprint or facial recognition to login into an account can enhance the safety of traders.

5) Country Risk

Forex trading involves buying and selling currencies. These currencies are used for day-to-day activities in respective countries. Each country has different growth rates and interest rates. Their price trends will be different for each pair.

The sudden price movement on any currency pair can occur at any time due to different reasons. A country might implement expansionary or contractionary monetary and fiscal policies that can affect price trends. Country risk is more effective in automated trading as policies implemented by countries can alter the course of price trends.

There are multiple risk elements in the forex market. Choosing the right broker, taking informed decisions, technical and fundamental analysis, and other precautionary measures will reduce the risk factor. However, risk in the forex market can be mitigated but cannot be removed completely.

Leveraged forex trading involves significant financial risk. Forex trading is easily accessible for retail traders. More than 70% of forex traders face losses. It is always advisable to use the demo account and trade with virtual currencies before trading with real money. This will also allow traders to know whether forex trading is suitable for them or not.

To mitigate these risks, forex traders should:

• Educate themselves about the forex market and trading strategies.
• Use risk management techniques, such as setting stop-loss orders and position sizing.
• Avoid excessive leverage and only trade with capital that they can afford to lose.
• Stay updated on economic events and news that may impact the forex market.
• Remain disciplined and avoid making emotional decisions based on short-term market movements.

Risk management techniques in forex trading

Position Size: Determine trade size based on account balance and risk tolerance (1-2% per trade).

Stop-Loss: Set stop-loss orders to limit losses if the market moves against you.

Take-Profit: Use take-profit orders to secure gains at a predefined level.

Risk-Reward Ratio: Aim for favorable risk-reward ratios (1:2 or better).

Diversification: Spread risk by trading different assets, not all in one.

Control Leverage: Use leverage carefully to align with risk tolerance.

Trading Plan: Develop a clear plan with entry/exit rules and risk limits.

Emotions: Manage emotions to avoid impulsive decisions.

Stay Informed: Be aware of market events that could impact trades.

Monitor Trades: Adjust stop-loss and take-profit levels as needed.

Review Trades: Analyze trades to learn and improve strategies.

Avoid Revenge Trading: Don’t trade impulsively to recover losses.

Forex trading can be rewarding, but it is crucial to approach it with a clear understanding of the risks involved and to trade responsibly. Traders should consider seeking advice from financial professionals and only trade with money they can afford to lose.

Pros of Forex Trading

Following are the advantages of trading forex:

Largest Capital Market

You invest in the world’s largest financial market. With daily transactions crossing over USD 5 trillion, the sheer size of the forex market makes it truly a global marketplace with several profit opportunities.

24-Hour Market

The forex market operates around the clock so that you will find a trading opportunity any time of the day in at least one global time zone. As the forex market is a decentralized OTC market, its working hours are not subject to any centralized exchange system. For instance, trading hours begin at 5 PM EST in the USA on Sunday and roll continuously with other markets until Friday at 5 PM. Note that even though currency trading is restricted for retail traders on weekends, the exchange rate keeps moving.

Low Capital Requirement and Lower Transaction cost

In addition to very low investment requirements, even the transaction cost of trading forex is relatively lower. For instance, you can start dealing in currencies with just USD 100 or even lower. The main earnings of a broker comes from the bid-ask spread. Spread is measured in pips, the difference between the sell and buy price of a currency. However, some brokers do charge a commission or flat fees per transaction. You should factor in commission and spread while choosing a broker to lower your overall trading cost.

Availability of Leverage

The availability of high leverage is perhaps the main reason why forex trading appeals to so many people. It enables you to place a higher trading order with minimum capital.

Almost all the forex brokers offer leverage where you can borrow against deposited money in your trading account. It’s similar to taking a mortgage against your property; the only difference is that the margin requirement is very low. For instance, you can place a USD 100 order with just 3.33 US dollars if your broker offers a 1:30 leverage ratio. However, leverage is a double-edged sword. It can amplify your losses, so heed caution when trading forex with leverage. You should avoid using high leverage.

Most Liquid Market

Forex market is also the world’s most liquid market. Liquidity refers to how quickly an asset can be sold or bought without affecting its value. Major currency pairs such as EUR/USD or USD/JPY are considered most liquid than exotic currency pairs.

Major pairs are more liquid hence the spread will be lower on major pairs. The spreads on less traded pairs are higher due to low liquidity.

Volatile

The same volatility, which makes it riskier for traders, can also present ample profit opportunities. Volatile market conditions cause rapid changes in the value of currency pairs, thus, increasing your chances of gains from the trade.

But this is also a big risk. If a currency pair changes in its value by a lot then it is considered volatile and can be a risk for investors as you can lose big if you are on the opposite side. For example, USD/TRY is considered a very volatile currency pair. You may lose quickly if you are in the wrong position, also you must consider the Swap Rates when trading such currency pairs.

Scalable

Scalable means you can trade in mini, micro, or standard lots, making it easier for traders to control investment size and capital exposure.

Affordable Technology

You don’t have to spend money on acquiring expensive hardware and software to start with forex trading. All you need is a computing device or a smartphone with a reliable internet connection. Your broker will provide charting and trading technologies at no cost once you subscribe.

Cons of Forex Trading

Following are the challenges or disadvantages of trading forex:

High Risk

Forex market is not ideal for many traders due to its high risk. The market risk in forex trading is much higher compared to other capital markets like stocks, commodities, etc. The involvement of leverage further increases the risk of losing a substantial amount within a few seconds.

The market is active 24 hours a day and any news event around the globe can affect the prices of currency pairs. Hence, at times it becomes impossible to correctly predict the price movement.

Lack of Transparency

There is no particular location from where the forex market is controlled or managed. Foreign currencies are exchanged in many ways mainly through central banks, private banks, large financial institutions, etc. The forex market is largely influenced by large-scale market makers, liquidity providers, and banks. Hence, there is no transparency about how the trade order is getting executed. The trading volume and market sentiment are also difficult to predict in the forex market.

Complex Valuation Method

The value of one currency in return for another keeps on changing due to multiple reasons at every minute. It is quite complex for retail traders to calculate the valuation of one currency in terms of another. The valuation depends on the economic and financial details of the involved currencies and their predictions. Compared to other capital markets, it is much more complex to do a valuation of the currencies.

Difficult to Learn

Stocks, commodities, and other markets are much easier to comprehend compared to the forex market. In the stock market, traders can get assistance from experts and portfolio managers. Comparatively, it is challenging to learn forex trading and understand the forex market. Traders have to learn most of the forex trading on their own.