Whether you are a trader or not, everyone has heard of the term ‘Forex Trading.’ Trading or exchanging currencies with the hope of making a profit is not a new concept. In 1982, investors realized the potential of exploring currency variations, and the first currency pair was traded. Controlled by a few professionals at that time, Forex trading has come a long way. Today, it is an open market where millions of traders, both novice and experienced, use currencies’ fluctuating strength to make a profit.
Forex is recognized as the marketplace that allows you to engage in the trading of many diverse types of currencies of the world’s nations. The forex market is considered to be the market that is the largest one on the globe at this present time that provides the highest level of liquidity as a result of the many trades being conducted in the number of trillions of dollars daily. For this market, it is noted that there is no existence of a location that is centralized. Instead, the forex market is set up to function as an electronic network that connects banks, institutions, brokers, and personal traders who conduct trades primarily via the usage of banks or brokers. So, what is forex?
Forex or foreign exchange is the largest and most liquid asset global marketplace for exchanging national currencies against one another. In the foreign exchange process, traders change one currency into another currency for commerce, trading, or tourism. The forex trading market is open 24 hours a day, five days a week, except for holidays. In the trading industry, traders attempt to profit by buying and selling currencies by speculating (predicting) on the direction currencies are likely to take in the near or distant future.
Forex is simply exchanging the currency of one country for the currency of another country. Generally, when you need to travel abroad, you need Forex. You give your home currency to the exchange and use its value to get the country’s currency that you are visiting. For example, if you live in the United States of America and wish to visit France, you will give USD to the exchange and get France used.
Such an exchange is done for a practical purpose. This is how many companies work with overseas clients, individuals, and even central banks to convert currencies. When the same exchange is done with profit-making motives, we call it trading. Forex is also known as FX trading and foreign exchange. Most traders are engaged in FX trading, averaging the daily trading at $5 trillion. Let’s explore the term ‘Forex trading’ further.
Currency needs are experienced by many people and organizations, such as personal investors and financial agencies. These people and organizations may conduct speculations regarding the movement of a designated pair of currencies. They place their orders to purchase and sell currencies via the forex market to have interactions about other orders regarding currencies that have been placed by other people and organizations.
What is Forex Trading?
In general, forex trading represents the conversion of one currency into another. Forex trading as a business represents a process when a network of sellers and buyers transfers or exchanges currencies among themselves at an agreed price with the hope of gaining from it.
Forex is a volatile asset, with some currencies having more momentum than the others. This volatility of currency depends on the amount of currency that is being converted every day. Volatile currencies are desirable as they offer an increased scope of making profits. However, one must keep in mind that volatility furthers the risk involved in trading.
What is the forex market?
So, let we see forex market meaning, forex market definition:
The forex market is a global network of computers and brokers worldwide, and it can be divided into the interbank markets and the over-the-counter (OTC) market. The interbank market is a market where large banks trade currencies on behalf of clients. The OTC market is a market where individual traders trade through online platforms and brokers.
Foreign exchange is made every single day. Ordinary people and business owners convert currency when they pay for goods and services abroad. For example, if you buy some products from the UK in GBP, you need to convert your dollars to buy that product. You did a foreign exchange.
But if you are a trader, you use a platform for buying and selling currency pairs, and you are part of the (OTC) market.
Working of Currency Markets
Forex trading takes place directly between individuals or parties. There is an over-the-counter, or OTC, which is different from the exchanges used for commodity or share trading. Legal Forex trading is highly regularized and is run by an international network of banks. There are four major Forex trading centers in the world in different time zones. These four time zones pertain to London, Sydney, Tokyo, and New York. Forex trading takes place 24*7 as there is a lack of a central location.
Types of Forex Markets
Depending on the types of exchange and contacts, Firex markets can be classified into three categories. These are:
1. Spot Forex Market
This includes the exchange of physical currencies. This exchange of a currency pair takes place on the spot, i.e., within a short period of time. The rates are agreed upon, and the exchange is made. Nothing happens at a later date.
2. Forward Forex Market
In this, two parties enter a contract where they agree to trade a fixed amount of Forex later. They set the exchange price and the date(s) on which the exchange will occur. No trade happens on the spot.
3. Future Forex Market
A futures contract is similar to a forward contract. The parties fix the prices, terms of exchange, and date on which the trade will occur. The most important difference between the two is that a futures contract is enforceable by law.
Understanding Currency Pairs
In FX trading, currencies are exchanged in pairs. Every trader selects a currency pair before entering the market. The first currency of the pair is called the base currency, and the second one is known as the quote currency. Traders have to sell one of the two currencies and buy the other one. A currency pair’s price is determined by how much a first currency unit is worth when converted to the quote currency.
The currencies are represented by three letters; the first two for their respective regions and the third one stands for the currency’s name. For example;
- GBP – Great Britain pound
- USD – United States dollar
- SGD – Singapore dollar
- JPY – Japanese yen, and more
The currency pairs are formed by using these codes of two countries. For example, if you are trading the Great Britain pound and the US dollar, the currency pair will be GBP/USD, with GBP being the base currency and USD being the quote currency.
The Currency Pair
Forex trading is based on buying one currency while selling the other. Let’s see what this is and how this is calculated by taking GBP/USD as our currency pair example.
Let’s assume that it is trading at 1.35361. Since GBP is the base currency and USD is the quote currency, we will say that 1 GBP is equivalent to 1.35361 USD.
The value of the currency pair depends majorly on the base currency. In this example, if GBP strengthens and its value increases against USD, the entire pair’s value will increase. In this situation, traders buy the currency pair. It is called holding a long position. Similarly, if GBP’s value decreases, traders will prefer to sell the pair by holding a short position.
Types of Pairs
While you can trade almost every currency, some currency pairs are more popular than the rest. It may be because of their value, volatility, or other aspects. To avoid any confusion, these currency pairs are classified into types. You can choose from the following:
Major Currency pairs
More than 180 currencies are traded globally, but only seven of these currencies account for 80% of the overall trade. The currency pairs made by these currencies are called major pairs, including EUR/USD, GBP/USD, USD/CAD, AUD/USD, USD/CHF, and USD/JPY.
Minor Currency Pairs
These currency pairs may not be traded as frequently as the major currency pairs; these are still considered important as they feature prominent currencies. The lack of popularity is because these currency pairs are exclusive of USD. Some of the minor pairs are EUR/CHF, EUR/GBP, and GBP/JPY.
Exotic Currency Pairs
These are the currency pairs where a popular base currency is paired with a quote currency from an emerging or small economy. For example, GBP/MXN (Sterling vs. Mexican peso), USD/PLN (US dollar vs. Polish zloty), and more.
Regional Currency Pairs
These are the pairs that belong to a region, such as Australasia and Scandinavia. Some of the currency pairs are AUD/NZD, EUR/NOK, and AUD/SGD.
Factors That Affect the Forex Market
Since there is no central location where the trade occurs, predicting the price movements can be challenging. Understanding the strengths and weaknesses of a currency is more difficult than predicting the price movements of stocks and shares. Many variables need to be considered. Although, just like other assets and securities, Forex is also influenced by supply and demand. Therefore, it is important to understand the supply-demand, which can be done with the help of the following:
Central Bank Policies
The central bank of a country controls the currency supply. It makes certain policies and takes measures targeted to influence the strength of the currency. For example, quantitive easing is done to drop the price of a currency. It involves pushing more money in the country, hence, decreasing the demand.
You cannot write an email to the country’s president if you have doubts about the currency. To know whether you are putting your money in the right trade or not, you need to know more about the economy and its strength. You can economy-related information from the news reports. Positive information increases demand the currency as more people are willing to invest. This will increase the price of that currency, given that there isn’t a parallel increase in the supply.
Market sentiment, a reaction to the news report, plays an important role in deciding a currency’s price movement. By buying or selling a currency in large numbers, traders can convince others to follow their footsteps, thus, driving the demand in their chosen direction.
Every country releases economic data that is integral to fundamental analysis. This data is crucial when it comes to analyzing how the country is performing. This is crucial for traders, facilitating them while understanding the central bank’s next move.
For example, let’s suppose inflation has risen above 2% in the Eurozone, which the ECB wants to maintain. This can be done by increasing interest rates. Traders can use this information, and they will buy more euros with the hope that its price will increase.
Every investor wishes to maximize profits while minimizing the risk involved. They would not want to invest in the currency of a country that has a poor reputation when it comes to repaying debts. Therefore, they will look at the country’s credit rating. Higher credit ratings are associated with lower risk.
Making the Trade
You can trade Forex in various ways, but they all include buying and selling currencies simultaneously. Forex trading was only done via brokers in the initial years, but the shift from offline trading to online trading has brought a significant change to the status quo. Now, you can take advantage of price movements without being dependant on anyone. CFD trading is one of the derivatives that you can use for the same.
CFDs allow you to open a position without complete investment. As these are leveraged products, you can move ahead by employing a fraction of your trade’s complete value. Leveraged products do not give you ownership of the assets. You can simply open a position based on your calculations about the market movements.
Keep in mind that leverage open doors to both profits and losses. Think of leveraged products as borrowed money that you have to return irrespective of whether you make it again or not.
Forex Trading Spread
When it comes to assets, we always pay more when buying them and getting less when selling them. The same applies to Forex as well. When you open a long position, that is, buy a currency, you pay more than the market price of the respective currency, but when you open a short position, that is, sell a currency, you get less than its market price. This difference between the buying and the selling prices is called the spread. The tighter the spread, the higher the profit.
A Lot in Forex Trading
You might be trading a few units of currency, but in reality, they are traded in lots or batches. The standard size of a lot is 100,000 units of the first currency. This is too much for an individual trader. This is why most of the Forex trades are leveraged.
When there is the conducting of trades on the forex market, this happens in lots. They are referred to as being micro lots, mini lots as well as standard lots. A micro lot is categorized as being a value of 1000 of a particular currency. Then a mini lot is categorized as being a value of 10.000 concerning a designated currency. Finally, it is noted that a standard lot is regarded as being a value of 100,000 of a particular currency. This is not the same as when you enter a bank to conduct the transaction of exchanging four hundred and fifty dollars for a trip. In such cases where there is the conducting of trades on the forex market, which are done electronically, set blocks of currency are applied for the trades’ placement. However, you can conduct the trading of any number of blocks according to your desires and preferences. For example, consider that it is possible to conduct trades for seven micro-lots, which would be a total of seven thousand, or three mini lots for a total of thirty thousand. Or you can also conduct trades of seventy-five standard lots for a total of seven hundred and fifty thousand.
Size of Forex
It cannot be denied that the forex market is distinctive from other markets. This is due primarily to its massive size. Normally, the volume of trading that is conducted here is ultra-large. For example, the Bank for International Settlements indicated that the daily average of trades was noted as being over five trillion dollars back in April of 2016. London, Singapore, Tokyo, New York, Sydney, Hong Kong, and Frankfurt have been deemed the largest foreign exchange markets.
Leverage in Forex
Since currencies are not traded in small batches and paying a huge amount is impossible for every individual, trades are made by employing leverage. It allows you to operate a larger amount in the market by investing a smaller amount. It means that you are not expected to pay for the full value of trade upfront. You have to keep a minimum deposit with your broker, also known as margin, based on which you can open a position with a larger amount. When a position is closed, you take home the profit or loss that you made on the amount that you were operating in the market. Let’s understand each of these components:
Margin: Margin is a prerequisite for availing leverage. This is the minimum deposit that you have to keep with a broker while opening an account. You will get leverage on this deposit, and it needs to be maintained till you close a position or an account. The margin amount requirement differs from broker to broker. It could even be as low as $100.
Leverage Ratio: Leverage ratio decides how much you can operate in the market by your margin amount. For example, let’s assume that a broker offers you a leverage ratio of 1:10, with $500 being your minimum deposit. A leverage ratio of 1:10 means that you can operate $10 in the market for every dollar you deposit with your broker. In over case, you can operate 10 times $500, that is $5000. This ratio is also subjective. The broker decides it.
Pips in Forex
A pip is the smallest change in the price of a currency pair. This change takes place at the fourth decimal place of the price. For example, if GBP/USD is currently priced at $1.34351, which moves to $1.34361 tomorrow, we will say that this currency’s price has increased by one pip. The units after the fourth decimal place are called pipettes or fractional pips.
The rule of considering the fourth decimal place is overlooked when the quote currency is in a significantly smaller denomination, like in the EUR/JPY currency pair. For this pair, we consider the second decimal place as one pip. For example, if the prices move from ¥106.472 to ¥106.482, it will be regarded as one pip movement.
Frequently Asked Questions
Q1. Who regulates the Forex market?
Since there is no central office where the trade place and this market operates 24/7, no one agency or authority can regulate this expansive market. Several individual regulatory bodies regulate Forex trading of their respective countries.
Q2. What is the volume of daily Forex trading
Forex trading is a very active market with a 24/7 engagement. The approximate worth of daily transactions is $5 trillion, equivalent to $220 billion an hour.
Forex trading time
The forex market operates twenty-four hours per day for five days each week. But it is to be noted that these operational hours do not apply to holidays. Yet, the reality is that there may be the conducting of trades for some currency types during a holiday time in such cases that the country or global market is regarded as being open for the sake of business purposes.
Those who are retail traders have the option to engage in opening an account on the forex market. They are then equipped to conduct the purchasing and selling of various currencies and trade two currencies against each other. The difference in the price that the pair of currencies purchased or sold for will determine if there is the provision of a profit or a loss.
There is another manner in which participation in the forex market can become a reality via forwards and futures. It is noted that there is the customization of forwards regarding currencies being exchanged following times of expiration. On the other hand, it is not possible to apply any form of customization to futures, and they are more widely applied by those who engage in conducting speculations. At the same time, it is understood that the positions frequently experience closure before the expiration time to prevent the formation of a settlement.
It is comprehended that the market in the financial sector, which is ranked as being the largest on the globe, is recognized as being the forex market. In general, retail traders do not desire to conduct the complete sum of currency for which they are conducting trades. They rather desire to profit concerning the differences between the various currencies over a span of time. Since this is the case, brokers conduct the rolling over of placements daily.
Pairs and quotes for forex
You can learn more about How To Read A Forex Quote in our previous article. When there is the conducting of trades in various currencies, pairs are used to list the currencies. Some examples of this include USD/JPY, EUR/USD as well as USD/CAD. It is noted that such listings provide a representation of the US dollar compared to the Japanese Yen, the Euro compared to the US dollar. Finally, the US dollar compared to the Canadian dollar.
Foreign exchange in modern times
The fact is that the forex market operates twenty-four hours per day for five days per week within the context of key centers of finance around the world. This denotes the reality that you can conduct the purchasing and the selling of currencies at your preferred time during the week.
From the historical perspective, it is realized that in past times, trading regarding foreign exchange was only made possible for hedge funds, major corporations, and governments. However, in modern society at this present time, it is rather easy to conduct the trading of various currencies with simply the click of a mouse. Therefore, access to the ability to trade on the forex is no longer a complex problem. This means that anyone who desires to engage in the conducting of trades on the forex market has the opportunity to do so. A wide range of banks offers individuals the opportunity, investment agencies, and retail forex brokers to engage in the opening of accounts for the sake of conducting trades of various forms of currency.
In such cases that you conduct trades on the forex market, this means that you are conducting the purchasing or selling of a designated type of currency for a specific nation about another form of currency. However, it is noted that no exchange of physical money transpires between two entities. This is what takes place at a kiosk that deals in foreign exchange. But since the forex is an electronic market, traders normally make a placement regarding a designated form of currency, hoping that there will be the experiencing of movement in the upward direction that would strengthen the currency that they are purchasing for the sake of obtaining a profit. Or if they are selling, they would hope for a weakness in the other form of currency to profit.
During the conducting of trades, there is the trading of a particular type of currency in correlation to another form of currency. This is always the case. When you conduct the selling of a type of currency, you are, in actuality conducting the purchasing of another form of currency. In terms of the trading world in the electronic realm, there is the achievement of a profit that is based on the differences in the prices of the currencies for which you conducted transactions.