Understanding the Basics of Forex Trading as Precursor to CFD Trading
Prior to entering into forex trading and entering into contracts for differences (CFDs), it’s important to first, fully understand how forex markets work. Basically, the term forex stands for foreign exchange, while trading refers to the buying and selling of major foreign currencies in forex markets. In other cases, forex trading also involves buying contracts for futures or price differences of foreign currencies.
.Where Does Forex Trading Take Place?
First off, it should be clear that there is no central marketplace for forex trading because the selling and buying occurs in an over-the-counter (OTC) setup. All major financial centers of countries have an OTC market that operates 24 hours each day of the 5 working days of the week.
Who Participates In Forex Trading
Any person, organization or country can participate in forex trading, whenever the need for a specific foreign currency arises. An American who will be travelling to Europe will have a need to purchase Euro Dollars (EUD) from an OTC forex outlet or from its accredited satellite sub-outlets, being the acceptable currency in the region.
Throughout the day across countries, consumers, travellers, business organizations including investors are into buying a certain type of foreign currency. In the meantime, the demand level for each currency will influence the exchange value. If the demand for a foreign currency is high, its exchange value in the market rises; conversely the exchange rate goes down if there is no or low demand.
What is an Exchange Rate?
Since forex trading denotes buying of one type of currency, the exchange rate determines how much of the buyer’s currency will be paid to purchase a unit of the currency needed. To illustrate by way of example, let’s say a U.S. company needs €1K (1K EUR) to pay for materials purchased from a firm located in a European country.
If the current exchange rate between EUR and USD is 1.2096, it means 1 unit of EUR is equivalent to 1.296 worth of USD. The currency pairing is EUR/USD, denoting that the US company has to shell out US$1,209.60 to buy €1,000. Here, the EUR/USD exchange rate of 1.2096 is simply multiplied by the €1,000 purchased.
Now if the example is reversed, wherein a European firm buys US$1,000, the mathematical operation is also reversed. The pairing of the two currencies will be flipped to USD/EUR, while the computation of the cost will require dividing a unit of EUR by the current exchange rate of 1.296. The USD/EUR exchange rate therefore is 0.7716 (1/1.296 is 0.7716), and the cost of 1,000 worth of US currency is only €771.60.
The examples above also explains why forex trading always comes in pairs, since one currency is selling while the other currency is buying. In a currency pairing, the first that is mentioned is called the base currency, while the second currency mentioned is called the counter currency. The exchange rate indicates the equivalent value of a unit of counter currency for every unit of the base currency.
Understanding Trading with Foreign Currencies by Way of CFDs
Forex trading known as a Contract for Difference does not require actual ownership of a foreign currency. A trader simply takes a position based on a projected difference between the exchange rate of two currencies; of whether the rate will increase or decrease by a certain spread or price difference. The outcome therefore depends on the performance of the two currencies in the forex trading market.
One of the online trading platforms that has been drawing a lot of CFD investors is an award-winning Malaysia-based platform known as Rakuten Trade. Based on a Rakuten forex trading review, this broker accepts forex trading only from members who have an existing Rakuten Forex account. Most of the time, the trading platform offers only fixed spreads during core-time trading periods of the month and based on HK time. However, Rakuten’s fixed base spread does not apply during extreme market circumstances, as spreads could widen beyond the figures offered.