What is Forex
The Forex market is an international market that trades the values of currencies relative to one another. It is sometimes also referred to as the “FX market,” “currency market,” “foreign currency market,” and “foreign exchange currency market.” These all refer to the same international marketplace with daily trades counted in the trillions of US dollars, making it the largest liquid market in terms of average daily turnover.
When it comes to the Forex market, there is no central marketplace wherein all the orders are processed in one place like what the stock market has with centres like the New York Stock Exchange. Instead, trading happens over the counter, meaning that transactions occur between traders worldwide via electronic networks. This allows the market to stay open 24 hours a day for around five and a half days a week. There are trading centres located in major cities around the world, namely New York, London, Zurich, Frankfurt, Paris, Tokyo, Hong Kong, Singapore, and Sydney.
In order to better understand Forex, one needs to appreciate the history of how currencies work.
Back in 1876, international currencies utilised the gold exchange standard. This meant that, while paper currency or cash was being used as a way to trade goods and services, its value had to be backed with solid gold. This was to stabilise the different currencies, but it led to erratic patterns in its value, which led to an end to the gold standard’s use.
Around the beginning of World War II, there was not enough gold to support all the currency being printed to pay for Europe’s military undertakings. However, gold still had a role when it came to determining the value of currencies, as the US dollar, the new standard by which all other currencies determined their value, was still backed by gold. This ended in 1971.
By 1976, the world almost universally accepted the use of floating foreign exchange rates. When the mid ‘90s rolled around, Forex trading, with the help of the internet, was being widely traded electronically.
How does it work?
If you want to try your hand at Forex trading, it is relatively easy to learn. The main thing you need to do is understand how the market works, so that you can predict how currencies behave. Forex trading is all about understanding how currencies rise and fall in relation to one another.
All Forex trades come in pairs, as having no gold exchange standard means that all currencies have no value in and of themselves, only when compared with other currencies. You choose a pair to trade in. The first currency in the pair is the base, which is what you will be buying or selling, while the second currency will be the counter, which is how you measure changes in value in the base.
For instance, if you are trading GBP/USD, then that means that you are trying to predict the rise or fall in value of the British pound against the US dollar. If you think that the pound will rise in value, then buy more of it. If you think that it will lose value, then sell it. Being the largest liquid market comes with the advantage of it being relatively easy to find a buyer when you want to sell and a seller when you want to buy.
Who participates in the Forex market?
You would be surprised just how diverse the participants of the Forex market are. Aside from retail Forex traders, who trade with brokers usually via the internet, there are all sorts of people who participate in the Forex trade.
Companies have to trade in foreign currencies whenever they do business overseas, as they have to buy goods and services in several countries.
Banks trade billions of dollars’ worth of foreign currencies each day, both for their customers and for themselves.
Governments and central banks use Forex in order to stabilise their markets. This often leads to changes in inflation and exchange rates.
Even individuals participate in the Forex trade when travelling overseas to countries with a different currency from their home country’s. This is so that they can buy goods and services while abroad.