What is the Forex Market?

The forex market (foreign exchange market) is the largest and most liquid financial market in the world, with a daily trading volume exceeding $6 trillion. It is active 24/5, unlike traditional markets. This way, traders can capitalize on currency fluctuations. 

The market is driven by a mixture of economic, political, and technological factors, that make the forex market both rewarding and challenging. There are many currency pairs in the market, from highly liquid majors to more volatile exotics. Once you get a hold of how global events affect the market, it's easier to select the currency pairs to invest in. 

The modern forex market began to take shape in the 1970s, following the collapse of the Bretton Woods system, which had established fixed exchange rates. This shift to floating exchange rates allowed currencies to be traded freely, leading to the establishment of the forex market as we know it today. Nowadays, with the latest technology and platforms, the market is more accessible and dynamic than ever before.

Currency Pairs

Forex trading is through currency pairs. Each currency pair has its own characteristics and requires different approaches and strategies when trading. There are three pair types: majors, minors, and exotics. Let's take a look at the currency pair types in more detail.

Major Currency Pairs

Major currency pairs consist of the most traded currencies globally and typically involve the US dollar paired with another major economy's currency. These pairs include EUR/USD, USD/JPY, GBP/USD, and USD/CHF, among others. 

They are known to have high liquidity, tighter spreads, and lower volatility. Major forex pairs are attractive for traders who are looking for stable conditions.

The characteristics of major forex pairs are heavily influenced by economic indicators, central bank policies, and geopolitical events. You can use technical and fundamental analysis to predict the movements of these pairs. Major currency pairs are suitable for various trading strategies, such as scalping and long-term investing. 

Minor Currency Pairs

Minor currency pairs are also known as cross-currency pairs. These pairs involve major currencies but do not include the US dollar. Examples include EUR/GBP, AUD/NZD, and GBP/JPY. Minor pairs may be less liquid than majors but they still offer quite good opportunities when trading. They come with unique opportunities provided by their sensitivity to regional economic conditions and market sentiment. 

Trading minor pairs requires a deep understanding of the underlying economies and potential correlations between different markets. It is possible to turn volatility in your favor when trading these pairs. However, you should consider the fact of wider spreads and less predictable price movements. 

Exotic Currency Pairs

Exotic currency pairs consist of a major currency paired with a currency from a smaller or emerging economy. Examples include USD/TRY, EUR/SEK, and GBP/ZAR. These pairs are known to have higher volatility, lower liquidity, and wider spreads. With characteristics like this, they are riskier but have a higher risk-reward ratio compared to others. 

Exotic pairs are often influenced by political instability, economic fluctuations, and changes in investor sentiment. Trading exotic pairs requires some understanding of how the forex market works. If you're planning to trade these pairs, it's better that you are able to analyze complex market conditions, and have strong risk management strategies. 

Factors Influencing the Forex Market

The forex market is influenced by many outside factors. Some of the most effective factors are:

• Economic Indicators and Reports
• Geopolitical Events and Market Sentiment
• Technological Advances and Market Trends

Economic Indicators and Reports

Economic indicators are important factors in forex trading. Here are the key indicators that you should be aware of as a forex trader:

• Gross Domestic Product (GDP)
• Inflation Rates
• Employment Data

These indicators provide insights into the economic health of a country and influence currency valuations. For instance, stronger-than-expected GDP growth or a decrease in unemployment can improve a currency's value as it signals economic strength.

These indicators are closely monitored by central banks to come up with policy decisions such as interest rate decisions. As a forex trader, you should follow the news about these policy decisions as well. The changes in the monetary policy could lead to profound effects on currency values.

Geopolitical Events and Market Sentiment

Geopolitical events can directly affect the forex market. These events include elections, trade negotiations, international conflicts, and disastrous activities. 

Market sentiment, driven by trader psychology and reactions to news events, also plays an important role in influencing currency movements. Traders often gauge market sentiment through indicators such as the Volatility Index (VIX) or by analyzing price patterns and trading volumes.

Technological Advances and Market Trends

Technological developments made the forex market more accessible. They helped the market to be one of the largest in the world. The technological advances showed their involvement in high-frequency trading, algorithmic trading, and the use of AI. These strategies have become essential in modern trading. 

Now with technological advances, trades are faster and full of data and patterns. They enable the traders to see things that are not visible through traditional analysis. 

Forex Trading Strategies

Forex trading is performed through strategies accepted by many traders. Technical and fundamental analysis are essential when trading forex. Also, position sizing is a good strategy to manage risk and maximize returns. Let's take a look at the strategies in more detail.

Fundamental Analysis

Fundamental analysis focuses on evaluating economic indicators, financial reports, and news events to determine a currency's intrinsic value. 

Fundamental analysis allows traders to analyze macroeconomic data such as interest rate decisions, inflation rates, and employment figures. This data is helpful to get a hold of the economic health of a country. This way, traders can adjust their trading decisions according to the data.

Technical Analysis

Technical analysis provides insights into the actual data that currencies are running through in real-time. The elements of technical analysis are chart patterns. With these patterns, traders can see and anticipate the future movements of their trades. 

Although it is important to be able to interpret the chart patterns, most of the time technical analysis by itself is not helpful to determine trading techniques. So, it is better to combine fundamental analysis with technical analysis to come up with better results. 

For example, if fundamental analysis suggests an economic uptrend, technical analysis can help identify optimal entry points based on price patterns and indicators. This combined approach allows traders to validate their hypotheses and enhance their decision-making process.

Position Sizing

Position sizing is basically saving a budget for a specific trade based on the trader's risk tolerance and the potential risk of the trade. It is a key factor in maximizing profits while minimizing losses. Position sizing is helpful for:

• Balancing risk and reward,
• Adapting to changing market conditions,
• Stronger trading psychology,
• Leveraging winning trades,
• Implementing Stop-Loss orders.

Forex Trading Example

Here's an example of a forex trade. Let's take a look at how to trade a major pair (EUR/USD):

A trader saw a consolidation pattern in the EUR/USD pair and expected a positive breakthrough. The trade was entered when the price broke above the upper Bollinger Band, and the RSI confirmed the upward trend. 

• Entry Point: Above the upper Bollinger Band with RSI > 70.
• Risk Management: Stop-loss placed below the lower Bollinger Band.
• Exit Strategy: Target profit set using the average true range (ATR).

Key Considerations When Trading Exotic Pairs

Trading exotic pairs like USD/TRY can be highly rewarding but comes with increased risks due to higher volatility and lower liquidity. Here are some essential considerations:

• Exotic currency pairs are volatile, they require wider stop-losses and more careful risk management.
• Since exotic pairs have lower liquidity, larger spreads and potential slippage are to be aware of.
• Exotics are more sensitive to geopolitical factors and economic instabilities. So, it is better to keep an eye on the news.
• The difference in the interest rates can influence long-term positions negatively. 

Forex Market in a Nutshell

The forex market offers many opportunities for traders. Liquidity, diverse currency pairs, and 24/5 trading are among the popular elements of the market. Currency pairs are divided into three categories; majors, minors, and exotics, each having their own characteristics. 

The forex market is influenced by factors such as economic indicators, geopolitical events, and technological advancements. With the knowledge and practice of the right strategies, you can maximize your profits and minimize risks. The forex market is the largest financial market in the world. So, if you are into trading, definitely check out and take part in this market with a trading volume exceeding $6 trillion.

FAQs

How to start trading forex?

To start trading forex, open an account with a reputable forex broker, deposit funds, and use their trading platform to execute trades. Ensure you understand the basics of forex trading, develop a strategy, and practice with a demo account.

What are the advantages and disadvantages of forex?

• Advantages: High liquidity, 24-hour market access, and leverage opportunities.
• Disadvantages: High volatility, leverage risks, and potential for significant losses.

What is the minimum capital needed to trade forex?

The minimum capital varies by broker. You can start trading forex with $10 on ZitaPlus!

Is forex too risky?

Forex trading carries high risk due to leverage and market volatility. Proper risk management, including using stop-loss orders and limiting leverage, is essential to mitigate risks.

How fast are the transactions in the forex market?

Forex transactions are typically executed almost instantly due to the market's high liquidity and advanced trading platforms.

Why is technical analysis alone not helpful?

Technical analysis alone may not be sufficient because it doesn't account for economic data, geopolitical events, and market sentiment, all of which significantly impact currency movements.

What are the forex trading platforms? 

Popular forex trading platforms include MetaTrader 5 (MT5) and cTrader. MT5 offers advanced charting, automated trading, and a user-friendly interface. cTrader is known for its intuitive design, fast execution, and powerful trading tools. Both platforms are available on ZitaPlus.