Foreign exchange trading: also known as FX or Forex trading is a global market for the money exchange of foreign currencies. Forex is the world’s largest market, and trading in it affects everything from the price of clothes imported from China to the amount you pay for water sports while on vacation in Thailand.
What is Forex trading?
Forex trading is akin to the currency exchange you might make when traveling abroad: a trader buys one currency and sells another, and exchange rates fluctuate constantly based on supply and demand.
Forex Market is a global platform where currencies trade 24 hours daily from Monday to Friday by Forex brokers. All Forex trading is over-the-counter (OTC), meaning there is no physical exchange (like stocks), and a global network of banks and other financial institutions monitors the market.
Most trading activity in the Forex market occurs between institutional traders, such as multinational corporations, fund managers, and People working for banks. These traders do not necessarily intend to control the currency themselves; they can only speculate or hedge against future exchange rate fluctuations.
For example, a Forex trader may buy US dollars (and sell Euros) if he believes the dollar’s value will appreciate and therefore buy more Euros in the future. Meanwhile, US companies operating in India could use the Forex market as a hedge if the rupee weakens, meaning the value of the revenue they earn there will fall.
How do currencies Trade?
All trade currencies are assigned a three-digit code identical to the stock symbol. While there are over 170 currencies currently used in the world, the US dollar is the most commonly used currency for forex trading, written as USD. After the United States Dollar, Euro (EUR) is the second most popular currency in the foreign exchange market. 20 out of 27 EU member countries officially use the EUR as currency.
There are many other popular currencies like the British pound (GBP), Japanese Yen (JPY), Canadian Dollar (CAD), Arab Emirates Dirham (AED), Australian Dollar (AUD), and New Zealand Dollar (NZD).
All Forex trading generally expresses a combination of two currencies exchange. The following seven currencies are known as the top exchange currencies and account for around 75% of trading on the Forex market:
- EUR/USD
- GBP/USD
- USD/JPY
- NZD/USD
- AUD/USD
- USD/AED
- USD/CHF
How is Forex trading quoted?
Each currency duo represents the current exchange rate for both currencies. How to interpret this information using the example of the EUR/USD exchange rate or the euro-dollar exchange rates:
- Left side currency (EUR) is the base currency.
- The currency on the right (US dollars) is the quote currency.
- The exchange rate indicates how much-quoted currency is required to buy 1 unit of the base currency. Therefore, the base currency is always defined as one unit, while the quote currency differs depending on the present market and how much it costs to buy 1 unit of the base currency.
- If the GBP/USD exchange rate is 1.25, it means that £1 buys $1.25
- When the exchange rate rises, the base currency appreciates against the quoted currency (because £1 buys more US dollars), and vice versa.
Three ways to trade Forex
Most Forex trading is not for the purpose of exchanging currencies (as you might do when traveling the currency exchange), but rather for speculating about future price movements, much like trading stocks. Like stock traders, Forex traders try to buy up currencies they think will appreciate against other currencies, or get rid of currencies they think will lose purchasing power.
There are three types of Forex trading to suit traders with different goals:
The spot market is the central Forex market where trade currency pairs (like GBP/USD or EUR/USD) and the exchange rates are defined based on real-time supply and demand.
The Forward Market: as a replacement for conducting a trade now, a Forex trader can enter into a binding agreement with another Forex trader and set an exchange rate for an agreed-upon price of currency at a later date.
Futures market: Similarly, Forex traders can choose standard agreements to buy or sell a predetermined amount of currency at a specific exchange rate in the future. It happens on an exchange, not in person, like in the futures market.
Forex traders use future and forward markets to speculate or barrier against future changes in currency prices. Exchange rates in this market depend on what happens in the spot market, the largest foreign exchange market, and where most foreign exchange transactions occur.
