What is Forex?
Forex markets are based on the cash markets of the world. The many forex
currencies can be traded via a broker.
The Forex (also known as FX), or foreign exchange market is a far reaching financial tool used by multi-billion dollar companies and small individual investors to derive profits from even the smallest fluctuations in currency exchange rates on the foreign exchange market. “Forex” is an interbank market created in 1971 when international trade transitioned from fixed to floating exchange rates. Since then the rates of currencies relative to each other are determined by the most obvious means, which is the exchange at a mutually agreed rate.
The footprint of the Forex market itself is enormous due to its global application. The market can be better understood by comparing its performance to other markets: The Forex market surpasses every other market in terms of volume. For example, the daily turnover of world equity market is estimated at $300 billion, while Forex trading approaches 2 trillion to 3 trillion U.S. dollars each day. Trading occurs non-stop, every minute of every day, from Monday through Friday. The Forex market is widely considered a pure market and free from any external control, which leads to a “perfect” market since the price of a currency is based solely on the supply and demand of a particular currency.
The idea behind using the foreign exchange market to make profits is the same basic strategy used for nearly all investments: to buy goods at a low price and to then sell them at a higher price; or similar to shorting equities by selling at a high price and covering (buy back) at a lower price. On the foreign exchange markets, goods represent currency and exchange rates of different countries. Banks carry out Forex transactions for settlements between counterparts from different countries for interstate payments, speculation, etc. The goal of a foreign exchange trader is to determine currency direction and buy the currency that rises in price, and to sell the currency that falls, and then make profits executing reverse transaction.
Forex was previously unavailable to ordinary people due to the fact that in order to get access to it people needed to have large sums (about $1 million) of money for investment. In recent years, the widespread use of the Internet and personal computers-which began in the 1990s-has taken currency trading to a whole new level. It is now possible for almost anyone to open an account and participate in the Forex market.
There are literally hundreds of currencies throughout the world (most of which are tradable), but there are several key currencies that account for the majority of Forex volume. The most popular currencies are referred to as the major currencies:
- Dollar (USD) – United States
- Euro (EUR) – European Union Members
- Yen (JPY) – Japan
- Pound (GBP) – Great Britain
- Franc (CHF) – Switzerland
- Dollar (CAD) – Canada
- Dollar (AUD) – Australia
- Dollar (NZD) – New Zealand
Currency is always signified in Forex with 3 letters. The first 2 letters designate which country the currency is from and the last letter identifies the name of the country’s currency. For example, the Canadian currency is shown as “CAD” with “CA” signifying Canada and the “D” representing Canada’s currency of the dollar.
There are three markets for a Forex investor to trade currency, the spot market, the forward market, and the futures market. The spot market is currently the largest market for exchange, however, in the not-so-distant past the futures market was popular since investors could hold currency for long periods of time.
The spot market is where currencies are bought and sold according to their current price. A particular currency is exchanged for another currency based on the currently agreed upon exchange rate. These exchanges are typically facilitated by either a broker or a bank.
In the futures market, contracts are bought and sold based upon a standard size and settlement date on public commodities markets. Investors agree to buy or sell a fixed amount of a specific currency at a fixed exchange rate on a fixed date in the future.
Forwards markets are similar to futures markets; however the terms of a contract between two parties are determined solely by the parties involved and don’t have to be based on a public commodities market.
The forwards and futures markets are often used to hedge against trades made in the spot market similar to purchasing options to hedge against a long equity position.
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