Understanding what forex is and how it works
The Foreign Exchange Market
The world’s largest market
Trading Foreign Exchange:
The FX market is by far the world’s largest market. Why? Because exchanging one currency for another is vital for the world’s business and trading.
The foreign exchange market allows two currencies to be exchanged, at an exchange rate which is floating or fixed. This allows businesses from around the world to complete transactions across currencies. Currencies need to be exchanged to import produce from different countries, for example: a wine merchant in England exchanges their pound sterling (GBP) for euros (EUR) in order to purchase wine from France. Exchanging currencies is the basis for all international trades. Unlike the stock market, the forex market is decentralised – this means that there is no central trading area. Most foreign exchange transactions are executed over-the-counter (OTC) by banks, on behalf of their clients.
Where did it start?
It all began with the gold standard monetary system back in 1875. Before our current system was born, gold and silver were exchanged for goods and services. The problem was that gold’s value changed depending on the supply – if a new source was discovered, gold would become less valuable. Eventually, different countries began to peg an amount of their currency to an ounce of gold. The difference between these amounts was an exchange rate. After World War One this system broke down, and several years later currencies were no longer pegged to gold.
FX trading used to be completed exclusively through banks and forex brokers. However, as technology has developed, FX trading has become far more accessible. Individual traders can now access the FX market from their smartphones, and complete trades on the go.
Today, the forex market is open 24 hours a day, 5 days a week. The first markets open on Monday morning in Wellington, New Zealand, and the last close at 5pm (ET) on Friday in New York.
Who is a Forex Trader?
An FX trader is any individual who exchanges one currency for another. Individual traders commonly use different platforms to exchange foreign currency. These include banks, financial institutions, money changers, or FX brokers. Most trades are completed over-the-counter, which means that the trade is facilitated via a bank rather than a centralised entity.
What is Forex Leverage?
Forex leverage is offered by brokers to enable traders to maximize their trading potential. The forex market offers higher leverage than other markets, and this attracts potential traders. Leverage allows traders to deposit small amounts and trade with high volumes. The term ultimately means borrowing money in order to increase the potential returns on a trade, but this means losses get increased too.
What is a Forex Swap?
A swap is simply an exchange of one currency for another. At a later date, the two parties who made the swap will receive their original currency back with a forward rate. The forward rate locks in a specific exchange rate and therefore acts as a kind of hedge. The swap varies significantly among different financial instruments.
What are Forex Signals?
Forex signals are trade forecasts usually issued by knowledgeable and experienced signal providers.
The signals are based upon a series of technical analyses or news events, and are used by traders to help them decide whether they should buy or sell a currency pair. Day traders in particular may use a variety of forex signals to inform their next trade. Forex signal systems produce either manual or automated signals.
In a manual system, the trader actively looks for signals and interprets them to choose whether to buy or sell. In an automated system, the software identifies a signal and makes the programmed response.
What is Foreign Exchange?
Foreign exchange is the market where one currency is exchanged for another. It is always done in pairs; for example if a trader wants to buy Euro and sell the US Dollar, then he would be trading the EUR/USD currency pair.
Similarly if a trader wants to sell the US Dollar and buy the Japanese Yen he would be trading the USD/JPY pair. The price of a currency pair is called the exchange rate. It is determined by political, economic and environmental factors.
Transactions in foreign exchange are usually conducted in high volumes. Foreign exchange market has no physical location and hence it is called a decentralised market. It is open 24 hours a day, 5 days a week and is the largest market in the world.
What are Forex Reserves?
Forex reserves are foreign currencies held by a central bank in order to grant greater flexibility and resilience.
A reserve is any currency held by a financial authority which is centralised. The reserve assets can be used to endure market shocks if a particular currency becomes devalued or suddenly crashes. Higher foreign currency reserves ultimately mean lower risks associated with exchange rate fluctuations.
Forex reserves are usually held in US dollars, British pound sterling, euros, Chinese yuan or Japanese yen. This is due to these currencies being the most common on the foreign exchange market.