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What is Forex and How Does it Work?
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What is Forex Trading?
Forex, or foreign exchange, can be explained as a network of buyers and sellers who transfer currency between each other at an agreed price. It is the means by which individuals, companies, and central banks convert one currency into another - if you have ever travelled abroad, then it is likely you have made a forex transaction. While a lot of foreign exchange is done for practical purposes, the vast majority of currency conversion is undertaken with the aim of earning a profit. The amount of currency converted every day can make price movements of some currencies extremely volatile. It is this volatility that can make forex so attractive to traders: bringing about a greater chance of high profits, while also increasing the inherent risk.
How Currency Markets Work
Unlike shares or commodities, forex trading does not take place on exchanges but directly between two parties, in an over-the-counter (OTC) market. The forex market is run by a global network of banks, spread across four major forex trading centres in different time zones: London, New York, Sydney, and Tokyo. Because there is no central location, you can trade forex 24 hours a day, five days a week. There are three different types of the forex market: Spot forex market: The physical exchange of a currency pair, which takes place at the exact point the trade is settled - i.e., 'on the spot' - or within a very short period of time. Forward forex market: A contract is agreed to buy or sell a set amount of a currency at a specified price, to be settled at a set date in the future or within a range of future dates. Future forex market: A contract is agreed to buy or sell a set amount of a given currency at a set price and date in the future. Unlike forwards, a futures contract is legally binding. Most traders speculating on forex prices will not plan to take delivery of the currency itself; instead, they make exchange rate predictions to take advantage of price movements in the market.
What Moves the Market?
The forex market is made up of currencies from all over the world, which can make exchange rate predictions difficult, as there are many factors that could contribute to price movements. However, like most financial markets, forex is primarily driven by the forces of supply and demand, and it is important to gain an understanding of the influences that drive price fluctuations here. Central Banks Supply is controlled by central banks, which can announce measures that will have a significant effect on their currency's price. Quantitative easing, for instance, involves injecting more money into an economy, and can cause its currency's price to drop. News Reports Commercial banks and other investors tend to want to put their capital into economies that have a strong outlook. So, if a positive piece of news hits the markets about a certain region, it will encourage investment and increase demand for that region's currency. Unless there is a parallel increase in supply for the currency, the disparity between supply and demand will cause its price to increase. Similarly, a piece of negative news can cause investment to decrease and lower a currency's price. This is why currencies tend to reflect the reported economic health of the region they represent. Market Sentiment Market sentiment, which is often in reaction to the news, can also play a major role in driving currency prices. If traders believe that a currency is headed in a certain direction, they will trade accordingly and may convince others to follow suit, increasing or decreasing demand.
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