What is Forex Trading

When most people hear the term Forex Trading, they think it is some sort of rocket science, only more complicated because there are no fixed rules, and it involves too many bars and charts and graphs all pointing out numbers and figures in different currencies of countries you didn’t know existed.

Essentially people don’t understand how someone could trade it, much less make a profit off of it. Forex Trading is the same as trading on the stock or share market – only on a slightly larger scale, with many more variables, and therefore, a higher degree of speculation involved.

The Purpose of Trading

As with all trading, the purpose of Forex Trading is to make a profit, by selling at a price higher than the buying price. Forex Trading is similar to any kind of buying and selling, in that it involves exchange of equivalent values. When you buy a product, you pay what is its equivalent value in terms of money.

Before currency came into existence, people would pay for one product, with a product that was thought to have a similar value. When you buy the shares of a company, you’re essentially buying the company’s value in the market, hoping that it will appreciate so that you can make a profit when you sell that value off.

Forex Trading is exactly the same, except that in place of companies, you have countries and in place of stocks, you have currencies. When you buy currency, you’re buying the country’s value in the global market. You pay for this currency with an equivalent value of another currency. This ‘equivalent value’ is established by means of the exchange rate between the two currencies, called the forex rate or exchange rate.

In layman terms, exchange rate is simply ‘how much of one currency is equal to how much of the other.’ Forex Trading revolves around the behaviour of this exchange rate. The exchange rate will determine whether it is profitable to buy or to sell.

The Forex Trading Example

For instance, if you were to travel from the US to China, you would have to convert your dollars to Yuan. Thus, if you had $100 on you, depending on the exchange rate, you’d get a certain amount in Chinese Yuan, let’s say, USD 100 = CYN 600.

Literally speaking, you’ve exchanged currencies keeping their values similar or you’ve ‘bought’ CYN 600 with your $100. Now, if this exchange rate were to change to, let’s say, USD 100 = CYN 700, it means that with the same amount in USD, you can buy more Chinese Yuan. Essentially, you’ve made profit.

This example, although over-simplified, gives a basic understanding of how Forex Trading works.

Conclusion

It may seem far-fetched to think that one can actually buy and sell currency. We always think of buying ‘things’ with money but never money with money. However, the truth is that all money represents a value, and this value is determined by what it can buy us.

Therefore, when you trade foreign exchange, the currencies that are bought and sold too represent a value. Within their own country, the currencies are valued for they can buy – in terms of goods and services. Outside the country, the currency is valued for what it can buy in other countries.

When you buy goods of one country with the currency of another, what you are essentially doing is buying their currency, with an equal quantity of your currency.

This is what Forex Trading is all about – only it is without any products or services – just direct exchange of currencies.