What is Forex Trading?

By information.com — Published October 11, 2017

What is Forex Trading?

What is Forex Trading?

Forex, also called FX, simply stands for foreign exchange. It refers to the conversion and trading of one currency to another and therefore is also known as currency market or forex finance. It is a global decentralized market where all the currencies of the world are traded against each other. Whether selling, buying or exchanging currencies at a current rate, also known as floating or a fixed rate, forex trading encompasses all.

The forex market is the world’s largest financial market with its daily trading averaging more than $5 trillion. It is also the world’s most liquid and volatile market. This volatility is what makes forex trading so attractive to traders worldwide. There are more risks involved, however, if done right, you would be able to earn more profit!

Why do people trade forex?

The main reason why people undertake forex trading is that they aim to earn a profit. Although the reasons may differ from person to person, there are two major activities that constitute a huge portion of everyday forex trades.

  • Purchasing foreign goods and services

The most common form of forex trading, purchasing goods and services abroad requires a business or an individual to exchange currencies. So, if you have ever traveled abroad or purchased anything online from another country, it means you have made a forex transaction. In other words, forex is necessary for international trade.

It is important to note that even though foreign currency exchanges for practical purposes are made every minute of the day, they do not constitute a huge portion of all forex trading. Instead, most people trade currencies to make a profit out of it, which is discussed in the second point.

  • Speculation by traders/investors

Usually, traders who speculate on prices or rates of foreign exchange do not intent on taking delivery of the currency itself. Rather, they aim to take advantage of movements in the forex market.

If you are a major investor, you can make huge numbers of large forex trades even in just one day. They constantly react to and anticipate changes or movements in the price of a currency. One reason why forex is the most liquid market in the world is that it makes trading currencies against each other relatively easy and simple. This is also why forex is much more volatile than any other financial market.

Mostly, international banks like Barclays and Citigroup are the biggest traders in the forex market. They aim to take advantage of the fluctuating exchange rates in the forex market and make a profit off them. A lot of individual traders make up a huge portion of the market too.

Governments and central banks also involve themselves in the forex market so as to keep their economy under control by regulating the supply of currency. Apart from these, businesses and other financial institutions, and everyday consumers also participate in the market directly or indirectly through overseas transactions, foreign market investments or traveling abroad.

What influences exchange rates?

As is the case with most financial markets, exchange rates or price movement in the forex market is determined mostly by supply and demand. Huge banks and other investors all over the world choose to invest their capital into sturdy and stable economies so that they can make secure investments and make as much profit as they can. So, if a particular region or country is hit with positive news financially, it will attract more investment, thereby increasing demand for that particular region or country’s currency.

This means that unless there is a corresponding increase in that currency’s supply, the difference between the supply and demand will result in increasing prices. Likewise, if a region is hit with negative news, it will discourage investments and foreign businesses, thereby decreasing the currency’s exchange rate. This implies that currencies are reflections of a region’s economic health.

In other words, forex prices go up when the circulation of a particular currency decreases or the demand for it increases. On the other hand, forex prices decrease when currency circulation increases or demand for that particular currency decreases.

Where do you trade forex?

Unlike the stock market, forex trading is decentralized. Or in other words, there is no physical place where currency exchanges are made. Instead, there is a direct exchange between the two parties involved, in a process known as over-the-counter (OTC) market.

So, the forex market, in principle, is run by a worldwide network of banks, which is spread across four main trading centers, all in different time zones. These centers are in New York, London, Tokyo, and Sydney. Forex can be traded 24 hours a day since they do not have to go through any central location. Keep in mind that you will need a forex broker.

How do you trade forex?

Similar to exchanging stocks, you can trade forex based on your predictions for the value of a particular currency. So, if you think a currency’s value will increase, you can buy it. If you think that’s it is headed toward a lower value, you can sell it or choose not to buy. Since the market is huge, the world’s biggest market, to be precise, it is often not difficult to find e-buyers and sellers anytime. For example, if you hear that India is reducing its currency value in order to attract more foreign investments into the country, you can make a forex trade by selling the Indian currency, the Rupee (INR) against another currency, for example, the US dollar (USD). The more the difference between the two currencies, that is, the more the Indian Rupee devalues compared to the US dollar, the more profit you will make.

Every forex trade constitutes two different currencies, as you are exchanging one for the other. For example, the most commonly traded pairs in the world are the Euro (EUR) and the US dollar (USD) or as it is represented in forex, EUR/USD. The first currency, EUR in this case, is called the base, while the second currency, the USD is called the counter. So, when a quoted price comes on, that price is the worth of one Euro in US dollars.

You will always see two prices on your platform. One is the selling price, while the other is the buying price. The difference between the two prices is called the spread. When you click either buy or sell, it is the first currency or the base currency that you are performing the action on.

It is important to understand that forex trading is not a way of becoming a millionaire overnight. As mentioned before, forex trading constitutes high profits, but at the same time, involves higher risks than other financial markets as well. You could lose money as easily as you make money. So always be careful, do your research, consult experts and never invest more than you can afford to lose.

As stated earlier, the FX market is the world's largest market, with a daily trading of greater than 4 trillion dollars. It is also a platform where the 'small fish' can score big, mainly because no one can control the FX market for a long period of time.

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