Forex is a portmanteau of foreign exchange and trading. Foreign exchange is the practice of exchanging money for a variety of reasons, usually commercial or tourism. According to a 2019 three-year report from the Bank for International Settlements, the daily trading volume of forex reached $ 6.6 trillion in April 2019.
What is the Forex Market?
The foreign exchange market is where the funds are traded. Funds are important because they allow us to buy goods and services locally and across borders. International currencies need to be exchanged for foreign trade and business.
If you live in the United States and want to buy cheese in France, you or the company from which you buy the cheese should pay the French for cheese in Euros (EUR). This means that the U.S. retailer will need to exchange the same amount of U.S. dollars (USD) in Euros.
The same goes for walking. A French tourist in Egypt cannot pay in Euros to see the towers because it is not a local currency. The visitor has to exchange Euros in local currency, this time the Egyptian pound, according to the current exchange rate.
All forex trading is presented as a combination of two exchange currencies. The following seven currency pairs – known as majors — account for about 75% of the forex trading in the market:
- EUR / USD
- USD / JPY
- GBP / USD
- AUD / USD
- USD / CAD
- USD / CHF
- NZD / USD
How Forex Trades is quoted
Each pair of currencies represents the current exchange rate of two currencies. Here’s how to translate that information, using EUR / USD — or the euro-to-dollar exchange rate — for example:
- The left currency (euro) is the basic currency.
- The currency on the right (U.S. dollar) is a quote.
The exchange rate represents how much money you need to buy 1 unit of base currency. As a result, the primary currency is always expressed as 1 unit while the quote varies based on the current market and how much it costs to purchase 1 primary currency unit.
If the EUR / USD exchange rate is 1.2, then € 1 will buy $ 1.20 (or, to put it another way, it will cost $ 1.20 to buy € 1).
If the exchange rate rises, it means that the base price will rise in value compared to the value of the quotation (because € 1 will buy more U.S. dollars) and vice versa, if the exchange rate falls, it means that the base price will fall in value.
Quick note: Currency pairs are usually presented in the primary currency first and then the currency denominated second, although there is a historical meeting on how other currency pairs are defined. For example, the conversion of USD to EUR is listed as EUR / USD, but not USD / EUR.
Three Ways to Forex Trading
This how to trade forex guide is a great place to start.
Most forex trading is not intended for the purpose of exchanging currency types (as you might do in currency trading while traveling) but rather to predict future price movements, as you would in stock trading. Like stockbrokers, forex traders are trying to buy currencies with prices that they think will grow compared to other currencies or eliminating their potential buy potential.
There are three different ways to trade forex, which will accommodate traders with different goals:
Local market. This is a major forex market where those currency pairs are exchanged and exchange rates are determined in real time, based on supply and demand.
Forward market. Instead of doing the current trade, forex traders can re-enter into a binding (confidential) agreement with another trader and lock the exchange rate at the agreed price for the next date.
Futures market. Similarly, traders can choose a fixed contract to buy or sell a predetermined amount of currency at a certain exchange rate at a future date. This is done in exchange for a secret, such as a forward-looking market.
Past and futures markets are mainly used by forex traders who want to speculate or hedge against future price changes in currency. Exchange rates in these markets are based on what is happening in the forex markets, which are the major forex markets and this is where most forex trading takes place.
Forex Terms of Knowledge
Each market has its own language. Here are the words you should know before engaging in forex trading:
Type of currency. All forex markets include a currency pair. In addition to the majors, there is also a rare trade (such as exotics, which are the currencies of developing countries).
Pip. Short by percentage points, pip refers to the smallest price change that can occur within a pair of currencies. Because forex prices are quoted in at least four decimal places, the pipe is equal to 0.0001.
The spread of the bid. Like other assets (such as stocks), the exchange rates are determined by the maximum amount that consumers are willing to pay in the form of cash (bid) and the minimum amount required by sellers to sell (ask). The difference between the two prices, and the amount sold at the end.
Lot. Forex is traded for what is known as the majority, or unit of fixed currency. The average lottery size is 100,000 units of currency, although there is a small lot (1,000) and a mini (10,000) available for trading, too.
Leverage. Because of that huge amount of revenue, some traders may not be willing to invest so much in trading. Equity, another term for borrowing, allows traders to participate in the forex market without the amount of money required otherwise.
Margin. Leverage trading is not free, however. Traders should prioritize money as a deposit – or so-called margin.
What Motivates the Forex Market
As with any other market, prices are set to supply and demand for retailers and buyers. However, there are other major forces at play in this market. The need for a particular currency may be influenced by interest rates, central bank policy, growth rates, and the political climate in the country in question.
The forex market is open 24 hours a day, five days a week, giving traders in this market the opportunity to respond to issues that may not affect the stock market until much later. Because trading is based on speculation or fencing, it is important for traders to be flexible, which can lead to sharp financial increases.
Risks of Forex Trading
Because forex trading requires energy and traders use margin, there are more risks to pre-trading than other types of assets. Currency prices are always volatile, but at very low prices, which means that traders need to make big trades (using power) to make money.
This rate is good if the trader makes a winning bet because it can increase profits. However, it may also increase losses, exceeding the original loan amount. In addition, if the currency is significantly reduced in value, power users open themselves up to calls, which may force them to sell their purchased securities at a loss. In addition to the potential losses, transaction costs can also consume what was once a profitable trade.
On top of all that, you should keep in mind that foreign exchange traders are small fish swimming in a pool of skilled, professional traders — and the Securities and Exchange Commission warns of potential fraud or information that may confuse new traders.
Perhaps it is a good thing then that forex trading is rare among individual investors. In fact, trading (i.e. non-professional trading) accounts for only 5.5% of the global market, figures from the DailyForex show, and some of the largest online retailers do not even offer pre-trading. Moreover, of the few forex traders who trade in forex, the majority are striving to turn a profit on forex. CompareForexBrokers found that, on average, 71% of FX traders who traded lost money. This makes forex trading a strategy often left to professionals.
Why Forex Trading Is Important For Medium Buyers
While the average investor should not find himself in the forex market, what happens there affects us all. Real-time activity in the local market will affect the amount we pay for exports and the cost of going abroad.
If the value of the US dollar is stronger against the euro, for example, it will be cheaper to go abroad (your U.S. dollars can buy extra Euros) and buy goods from other countries (from cars to clothing). On the other hand, when the dollar weakens, it will be more expensive to travel abroad and import goods (but export companies will benefit).
If you plan to buy more imported goods, or plan to travel outside the U.S., it is best to keep an eye on the exchange rates set by the forex market.