Required for the forex course
Forex account: free account at Markets.com
Duration per lesson: about 10 minutes
In the previous lesson of this Forex course for beginners we have discussed the question “what is forex”. In this lesson we will first discuss the practice of online forex trading. We will explain most concepts with the help of the software of markets.com, which we also use later in the course. Markets.com is one of the best forex brokers, which is also strictly regulated by the financial authorities. To be able to experience using the software yourself, you can easily create a free (demo) account at Markets.com.
As already mentioned in the previous lesson, currencies are traded in pairs. Examples of currency pairs are: EUR / USD, GBP / USD, USD / JPY (see below a list with explanations of currency abbreviations). This implies that you always speculate on the rise of one currency relative to the other currency. Opening a forex position is basically buying one currency pair while selling another at the same time. If the purchased currency increases in value compared to other currency, you will make a profit on the trade.
A currency pair is displayed as the two abbreviations of the currencies with a forward slash between them. Each currency has its own three-letter abbreviation. For the major currencies these are as follows:
- USD = US Dollar
- CHF = Swiss Franc
- EUR = Euro
- CAD = Canadian Dollar
- JPY = Japanese Yen
- AUD = Australian Dollar
- GBP = British Pound
- NZD = New Zealand Dollar
For example, the GBP / USD currency pair is the combination of the British Pound – US Dollar. The first abbreviation (GBP) is called the “base currency” and is the currency on which you speculate. So, if you buy GBP / USD, you expect the British Pound to appreciate against the Dollar. The second abbreviation (USD) is called the “quote currency” and is the currency against which you speculate. An expected increase of the British Pound in this case comes at the expense of the US Dollar.
You may have noticed that a lot of new terminology is used. As with most activities, the forex world uses its own jargon; pip, spread, bid, ask, long, short etc … do not let this put you off because you will learn this terminology very quickly. Besides, it can also be very fun when you can boast at parties with some advanced terminology of the forex market. For an explanation of all the terminology, see the forex dictionary.
Prices and spread
In the Markets software you can find the different tradeable currency pairs via the Filter. For example, for the Majors (the main currency pairs) you get an overview that looks like this (the exact prices and instruments will probably be different now since this is just a snapshot).
Behind each currency pair you will see two prices: the ‘Bid’ and the ‘Ask’ price. For the EUR / USD, the Bid price is 1.24634 and the Ask price 1.24664. The Bid Prize is the price at which you can sell Euros to the market, expressed in US Dollars. The Ask price is the price at which you can buy Euros.
The difference between the bid and ask price is the so-called “spread”. This is what you pay to the broker for opening the position. As opposed to other markets (such as the stock and options exchanges), the broker does not charge you any costs except the spread. Because of this, trading in Forex is also much cheaper for individual investors than trading on the stock market.
You should notice that the spread is very small; for the EUR / USD just three hundredths of a cent. In the forex world one would say: the spread is three “pips”. A pip is the fourth decimal place in the currency formats of most currency pairs. (Only for the Japanese Yen a pip is the second decimal point, because Yens are worth about a factor of a hundred less than most other currencies).
Long / short
There are two different types of positions; a long position and a short position. With a long position you speculate on a price increase of the base currency relative to the quote currency. If you take a long position on the USD / CAD, that means you are buying US Dollars and selling Canadian Dollars at the same time. With a short position you expect the price of the quote currency to rise in comparison to the base currency. In other words, you buy Canadian Dollars while simultaneously selling US Dollars.
The idea of a short position is hard to understand for many new traders. In fact, you sell something that you do not have. This is possible because you do not have to actually deliver the sold currency immediately; you only need to do so once you close the position. It is as if you are selling someone a bag of apples, without having those apples in your possession. You know, however, that you only have to deliver the apples to the buyer in a while. You speculate that in the meantime the price of apples will have dropped, so that at the time of delivery you can buy the apples at a cheaper price than you just sold them for. The same concept applies to forex trading as well.
To quickly get the hang of it, I recommend you make a few long and short trades yourself on the trading platform of Markets.com. See what happens to the value of your position when the price rises or falls. You will soon understand how long and short positions work exactly.