How to Trade Currency Pairs

What is Forex Trading?

Forex trading is trading between currencies of different countries. Currency rates are subject to constant change. Capitalizing on this change is what forex or currency trading is all about. Due to the computer revolution, forex trading has become less dependent of physical trading of currency. A trader today can in fact just resort to currency trading via a simple click of the computer. This facility has also helped in improving profitability as traders have the liberty to make purchases and sales instantly.

What is a Pip?

The full form of the term “Pip” is the price interest point and the pip is the change in exchange rate of one currency in comparison to another. The interesting fact of a pip is that it is based on a fluctuation of four decimal points. This signifies that one pip could in fact be an increase or decrease of 0.0001 points or 1/100 of a cent. A pip can also be theoretically defined as smallest price movement in terms of currency value fluctuation. A trader gains profitability on the number of pips earned, take for instance the value of a pip is $10 and your investment has gained you five pips, this means your profitability is $50. Another interesting fact is that most forex currency lots are purchased in volumes of $100,000. You profitability would be determined on basis of the number of pips multiplied by your investment.

What is a Currency Pair?

A currency pair is a comparison of 2 currencies, so to make trading possible, you need a price that is actually an exchange rate. For Example the EUR against the USD. Currency pairs are generally formed from two parts: the quote currency value and the base currency value. The base currency is the first currency that forms a part of the pair and the quote currency is the value of the base currency to the currency it is pitted against. The currency pair helps in determining how many units of the quote currency are required to purchase a single unit of the base currency. The fluctuation between the values once traded is called a pip.

What are Margins in Forex Trade?

A margin is basically a deposit you make in your trading account with your broker. It is this very margin that you deposit with a broker in good faith that helps you earn leverage. A broker will provide a trader with leverage based on the amount of margin you have deposited. Your profitability will be consequently added to your margin account and in the same way losses will be adjusted against the margins.

What is a Spread in Forex Trade?

The spread is the difference in purchase value or the bid price and the sale price which is called the asking price of the trader. The spread is the extra price that a trader would pay his broker to facilitate a purchase or a sale. In simple terms a Spread is your purchase or sale price including the broker’s commission. For example: a broker buys a Euro at 1.3401 to a dollar he would process it for you at 1.3402. Spread is a part of every Forex trading transaction; therefore a purchase and sale made at the same price would definitely be loss making for the trader in terms of the spread value charged.

How to Buy and Sell Currency Pairs?

Currency pairing is paying for one currency to basically buy or sell another. This very transaction of either a purchase or sale is called currency pairing. For example you pair two currencies the EUR/USD, the EUR in this case will be the purchase or sale (instrument) and the USD will be the finance or capital. This means that you are actually paying USD to buy or sell euro.

Buying or selling currency pairs is like trading on any other financial trading transaction, the only difference being the instrument; which is currency. The functioning of the Forex market is similar to equities or commodities but like every financial market, working in currencies required a lot of knowledge and understanding.

If you are a beginner it is always advisable to work with a stop loss of 30-40 pips and at the same time not use your complete volumes of leverage available.

So, let's take a look at the most traded Forex Instruments.

The four most traded currency pairs

There is no doubt the EUR/USD is the most traded currency pair in terms of market transaction value. Statistics reveal that 70% of all foreign exchange transaction is centred on the EUR/USD pairing. However this is a practice that is followed by large financial institutions and banks. For Forex traders the GBP/JPY is the most traded pair, the reason for this pair remaining popular among traders is the volatility associated with it.

It is very difficult for one to suggest which currency pair an investor must choose or trade in. This is purely a judgemental decision and should be made after a lot of research and understanding. It is advisable to be a good observer in the beginning to understand currency movement. If you are looking to trade currency pairs, it is advisable to choose a pair that is solid, sharp and volatile.

Other Popular Currency Pairs