What is Forex?

by Investing School on July 28, 2009

Forex (which is also known as the “Foreign Exchange Market,” “currency,” or “FX”) is the market where buyers and sellers complete transactions in foreign currencies. Investors strive to make money in this market according to the fluctuations in the values of different foreign currencies. It also exists to provide a way for banks and other institutions to have ready access to foreign currencies.

The foreign exchange market is a boon to international trade and investment. The presence of a foreign exchange market helps businesses convert their assets from one currency into another.

The Forex is a global market that exists because foreign convertible currencies are traded, and their rates of conversion can be measured against each other. The Forex market makes up the largest financial market in the world. It is so large that on an average day, Forex trades comprise roughly three trillion dollars worth of currencies! From this enormous amount, it is estimated that approximately 15 percent of that value is actually traded for goods or services. The remaining 85 percent of Forex activity is traded by speculators in the market. These speculators may be either individuals or financial institutions.

The foreign exchange market is different than other markets not only because it involves such high volumes of daily turn over. Foreign currencies provide a very liquid market with comparatively lower profit margins, and the nature of foreign currencies means that it is spread geographically throughout the world. Similarly, the Forex market is open for exceptionally long hours, opening at 22:00 on Sunday evening (UTC) and remaining open until the weekend begins at 22:00 on Friday evening (UTC).

Trading over the counter means that the currencies are traded directly between the two involved parties. Trades are decentralized, meaning that there is no particular financial center in charge of the process; rather, several locations around the world act as anchors for currency trades. Currency trades around the clock, barring weekend hours.

The process is relatively simple on the surface. One party purchases one type of currency paying with another. That said, you wouldn’t expect this kind of trading to make much money. The missing piece of the puzzle is that the trader only purchases currency that they believe will increase in value. This takes a good eye, an understanding of global economics and a bit of luck.

Even if the increase is small, if enough of the currency is purchased, and the trader can wait it out, they stand to make a significant profit. Many of these purchases are made through hedging, where the investor only puts up a portion of the money necessary to complete the trade. If the currency doesn’t increase in value the trader can end up owing a great deal of money.

Not surprisingly, this kind of trading has its own vocabulary which you will need to learn if you wish to participate.

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