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Now that you’re familiar with the basics of Forex trading, it’s time to dive deeper into how Forex trading actually works. Trading isn’t just about knowing what to trade.
It’s about understanding how to place and manage trades effectively.
By the end of this lesson, you’ll have a clear picture of the operational aspects of Forex trading, from how the market is structured to executing trades and managing risk.
One of the most important things to understand about Forex is that it’s a decentralized market.
Unlike stocks, which are traded on centralized exchanges (like the New York Stock Exchange), Forex is traded over-the-counter (OTC), meaning transactions happen directly between traders and brokers.
You might have heard the term "OTC" when buying medicine without a prescription. It simply means there’s no middleman like a central exchange.
In Forex, currencies are exchanged directly between buyers and sellers through electronic trading networks.
Even though there’s no single exchange, there are major financial hubs that drive the Forex market:
New York
London
Tokyo
Sydney
Because these financial centers open and close at different times, Forex operates 24 hours a day, five days per week, offering constant trading opportunities.
Before placing a trade, you need to answer a key question:
Which currency pair should I trade?
This decision is based on market analysis (which we’ll cover in later lessons).
For example, if you believe the Euro will strengthen against the US dollar, you might want to trade EUR/USD.
Trades in Forex aren’t executed manually. They go through brokers who provide online trading platforms.
These platforms connect traders to the market, offering price quotes, charts, and trading tools.
A broker acts as an intermediary, giving traders access to:
Market prices of currency pairs
Different types of trade orders
Leverage to control larger positions
Choosing a reliable broker is crucial for a smooth trading experience.
Every trade begins with an order, which tells your broker how you want to buy or sell a currency pair.
Different order types give traders flexibility in when and how their trades are executed.
A market order allows you to buy or sell a currency pair at the best available price.
When you place this type of order, you agree to trade immediately at the best available price in the market.
Since prices can change within seconds, the price you get may not exactly match the price you saw when placing the order. This is called slippage.
Example:
You want to buy EUR/USD immediately.
The current price is 1.1200, so you place a market order.
Your trade is executed immediately, but because prices move fast, the actual execution price becomes 1.1202.
This small difference of 0.0002 is slippage. Although market orders offer instant execution, they do not guarantee the exact price you expect.
A limit order lets you set a specific price at which you want to buy or sell a currency pair.
EUR/USD is currently at 1.1250, but you believe it will drop to 1.1200 before rising again.
You place a buy limit order at 1.1200.
If the price drops to 1.1200, your order is executed automatically.
A stop order is used to limit potential losses or lock in profits.
The most common type is a stop-loss order, which automatically closes your trade at a predetermined price if the market moves against you.
You buy EUR/USD at 1.1250.
To protect yourself from a big loss, you set a stop-loss at 1.1200.
If the price drops to 1.1200, your trade closes automatically, minimizing your loss.
Using stop-loss orders is essential for risk management.
As we discussed in the first lesson, leverage, margin, and spreads are key concepts when trading Forex. Let’s go over these concepts quickly again.
Leverage is a tool that allows traders to trade larger amounts with a smaller initial investment. It's essentially borrowing capital for trading.
For example, a 100:1 leverage ratio means that with $1,000, a trader can hold a position worth $100,000.
This increases the potential for profit but also increases the risk of substantial losses.
Margin is the amount of money required in your account to open and maintain a leveraged position.
It's a security deposit for the leveraged portion of your trade.
Expressed as a percentage of the full position size. For example, a 1% margin on a $100,000 position requires $1,000 in your account.
A margin call occurs when your account equity falls below the required margin level due to losing trades.
Spreads in Forex trading are the difference between the bid and the ask price of a currency pair.
In short, this difference is how brokers make their money, akin to a commission or transaction fee for each trade.
Types of Spreads:
Fixed Spreads: Remain constant regardless of market conditions.
Variable Spreads: Fluctuate based on market liquidity and volatility.
To better understand how all these concepts work in Forex trading, let’s take a look at an example.
Choosing a Currency Pair:
You decide to trade the EUR/USD currency pair.
Observing Bid and Ask Price:
The current bid price for EUR/USD is 1.1800, and the ask price is 1.1805. This means you can sell EUR/USD at 1.1800 or buy it at 1.1805.
Spread Calculation:
The difference between the ask and the bid price is 5 pips (1.1805 - 1.1800), which is the spread.
Using Leverage:
You decide to use a leverage of 100:1, which means you can control a position 100 times larger than your actual invested capital.
Determining Margin Requirement:
Suppose you want to control a $100,000 position. With a 100:1 leverage, the required margin would be 1% of $100,000, which is $1,000.
Executing the Trade:
You believe the Euro will strengthen against the US dollar, so you decide to buy EUR/USD at the ask price of 1.1805. You are effectively 'going long' on the EUR/USD.
Market Movement and Profit Calculation:
After some time, the EUR/USD price moves up to 1.1850 bid / 1.1855 ask.
You decide to close the position at the bid price of 1.1850.
The profit per pip is the difference in the entry and exit prices. In this case, the trade moved 45 pips (from 1.1805 to 1.1850).
For a $100,000 position, each pip is worth $10, so the total profit is 45 pips x $10/pip = $450.
Closing the Trade:
With a successful prediction, you exit the trade, realizing a profit of $450 minus any transaction fees or spreads.
Keep updating your knowledge about Forex trading.
Use demo accounts to improve your skills without risk.
Set defined goals and strategies for your trades.
Always set stop losses to limit potential losses.
Use leverage wisely to manage risks.
Avoid making decisions based on fear or greed.
Study market trends and economic news.
Keep up with financial news that can affect currency values.
Select a broker that meets your trading needs.
Forex is a decentralized market operating 24/5 through OTC trading.
Trades are executed through brokers who provide online platforms.
Order types include market orders, limit orders, and stop-loss orders.
Leverage, margin, and spreads are key factors in trade management.
A successful trade involves choosing a currency pair, executing with leverage, and managing risk.
With this knowledge, you’re ready to place your first trade! In the next lesson, we’ll explore market analysis techniques to help you make better trading decisions.
Our easy-to-use glossary breaks down complex trading terms into plain English. Learn the key terms every trader needs to know.
Explore our latest blog posts for trading tips, market insights,and real-world strategies. The XS blog keeps you informed, inspired, and ready to trade.
