## Foreign exchange market: How to trade on Forex?

Trading on Forex seems complicated, but the principle is simple. It involves buying and selling currencies with the aim of making a profit. Generally, however, most activities in the foreign exchange market are not individual traders looking to get rich, but international banks, corporations, and government agencies that need to exchange money for regular business operations.

The foreign exchange market, known as Forex (foreign exchange), is the largest financial market in the world by volume and liquidity. Foreign currencies are traded here 24 hours a day, five days a week through a global network of banks and brokers. Unlike stocks, which are traded on centralized exchanges, the foreign exchange market operates in a decentralized manner based on OTC (over-the-counter) transactions.

## Why do people trade currencies?

There are two basic reasons. The first is practical: companies that operate internationally need to exchange money. They need to lock in future exchange rates to know what costs to expect. This process is called hedging risk.

The second reason is speculative. Those who participate in Forex trading try to profit from fluctuations in exchange rates. These speculators are driven by one thing in the market: arbitrage and low entry costs. Financial leverage allows starting with a small capital and trading larger amounts. While entry into the stock market may require tens of thousands of dollars, you can start on Forex with 100 USD.

## How Forex Trading Works – Basic Terms

Currency pairs are the foundation of everything. Two currencies are traded together, for example, EUR/USD. The first currency in the pair is the base currency, and the second is the quoted currency. The EUR/USD pair indicates how many dollars you need to purchase one euro.

The most commonly traded pairs are GBP/USD ( also known as "cable" because it was transmitted by cable across the Atlantic Ocean in the 19th century ), USD/JPY, USD/CHF, and EUR/USD. These are called "major pairs" and have the highest trading volume.

### What is pip?

A pip is the smallest possible movement in an exchange rate. In most cases, it is a movement of 0.0001. If the GBP/USD pair moves from 1.3800 to 1.3801, it means a movement of one pip. Currencies with the Japanese yen have a different standard – a pip is 0.01.

Some brokers offer even greater precision – pipettes. For example, for GBP/USD, they may offer five decimal places instead of four.

### What is a lot?

Currencies are bought and sold in a specified size. One standard lot represents 100,000 units of the base currency. But at the beginning, it is not necessary to have such a large amount:

- **Standard lot**: 100,000 units
- **Mini lot**: 10,000 units
- **Micro lot**: 1,000 units
- **Nano lot**: 100 units

Calculating profit when trading on Forex is simple. If you buy one standard lot of EUR/USD at 1.1938 (100 000 EUR for 119,380 USD) and the pair moves by one pip, the profit is 10 USD. A movement of ten pips means a profit of 100 dollars.

## Financial Leverage – How Small Traders Make Money

Leverage is what makes Forex interesting for small investors. It allows you to borrow money from a broker and trade larger amounts than you have in cash. Leverage is expressed as a multiple – 10x, 20x, or even 50x.

If you have 10,000 USD and leverage of 10x, you have 100,000 USD to trade with. How does it work? Brokers keep a margin – a certain guarantee. With a 10% margin, it is a 10x leverage, and with a 2% margin, it is a 50x leverage.

Warning – financial leverage multiplies not only profits but also losses. If you take a loan with a leverage of 50x and the pair moves only 240 pips, your account will be liquidated and you will lose all your capital. Most brokers allow you to increase the margin on your account to avoid liquidation, but this adds extra stress and costs.

## How do you protect yourself? Risk mitigation

Companies do not trade on Forex just to make profits. They want to lock in future exchange rates so they know what costs to expect. This process is called hedging risk and works through futures and options.

### Futures contracts

Imagine that you are doing business in the Eurozone and you know that you will need US dollars in a year. You can enter into a futures contract now that obligates you to buy USD at an agreed exchange rate in the future. If the dollar appreciates, you will be protected. If it depreciates, you will pay a higher rate than the market rate, but at least you knew what to expect.

### Options

Options are more flexible. You pay a premium and gain the right ( but not the obligation ) to buy or sell a currency pair at a predetermined price. If the exchange rate moves unfavorably, you simply do not exercise the option and only the premium is lost.

## Covered Interest Arbitrage

One of the most interesting ways to earn on Forex is not trading, but arbitrage. Since interest rates vary around the world, you can borrow money in a country with a low interest rate, invest it in a country with a high rate, and profit from the difference.

For example, if the interest rate in the Eurozone is 1% and in the USA is 2%, with an investment of 100,000 EUR you can earn an additional 1,000 EUR. But beware – you need to lock in the exchange rate using futures to avoid the risk of exchange rate movements. After accounting for all fees and costs, the profit is often minimal, but safe.

## Where is currency traded?

Unlike stocks, which are primarily traded on centralized exchanges like the NYSE, trading on the Forex occurs in multiple locations around the world. The main ones are New York, London, Tokyo, and Sydney. Since the market has no central location, you can trade anytime – only on weekdays.

Most online brokers offer free access to Forex. You don't pay a direct commission, but brokers keep the spread between the buying and selling price (bid-ask spread). To start, choose a broker that allows you to trade in micro lots – it's the cheapest and most engaging way to familiarize yourself with Forex trading without significant risk.

## How does Forex differ from other markets?

Forex has several unique features:

- **Geographic coverage**: There are 180 recognized currencies in the world. Almost every country has its foreign exchange market.
- **Liquidity**: A huge trading volume means you will always find a buyer or seller.
- **Global factors**: Prices are influenced by politics, economic conditions, global crises, and even speculation.
- **24/5 opening**: The market is open approximately 24 hours a day, five days a week.
- **Low margins**: Profits are low unless you trade in large volumes. But with leverage, this changes.

## Closing Remarks

Trading on Forex is not easy, but it is accessible. With financial leverage, you can start with a small capital. However, leverage is a double-edged sword – it amplifies both profits and losses. Before you start trading, make sure you fully understand the mechanisms of how financial leverage works, and begin with micro lots and low leverage.

The foreign exchange market is ideal for those interested in the global economy and eager to understand how the value of currencies changes around the world. The more you study and practice, the greater your chances of success.