Explained in the simplest way possible, forex – also known as FX or currency exchange – is the exchange of one currency for another at an agreed price. It is a decentralized market where the world’s currencies are exchanged as in an OTC market, which means that transactions are fast, cheap, and completed without the supervision of a supervisor.
The currency market is always active
Basically, forex trading is the act of speculating on the movement of exchange prices when buying one currency while simultaneously selling another. Currency values rise (appreciate) and fall (depreciate) against each other due to a number of economic, geopolitical and technical factors.
Forex is a globally traded market, open 24 hours a day, five days a week (Monday through Friday). It opens on Monday mornings in Wellington, New Zealand, before moving on to Asian markets in Tokyo and Singapore. Then it moves to London, before closing Friday night in New York.
Even when the market remains closed from Friday to Sunday, something always happens that will wreak havoc in various currencies when it opens on Monday.
There is no bigger market than the Forex market
Forex is the most traded market, with an average turnover in excess of $5 billion a day. This means that currency prices are constantly fluctuating in value against each other, creating various trading opportunities for investors who take advantage of them.
It is rare for two different currencies to have identical value, and it is also rare for two currencies to remain at the same relative value for more than a short period of time.
You may not know it, but you have probably been part of the FX market at least once in your life. Let’s say you’re planning a vacation in the United States, and you need to change the money you’re going to take from euros to (EUR) to US dollars.
On Monday, you find a currency exchange establishment and see that the exchange rate for EUR/USD is $1.45. This means that for every euro you change, you get $1.45 in exchange. You spend 100€ to get $145.
However, you do the same trade a couple of weeks later and realize that the exchange rate for the EUR/USD is now $1.60. For your 100€ you now get $160 – $15 more – if you had known you would have waited for the euro to rise against the dollar to change the money.
The Basics of Forex Trading
Currency exchange rates fluctuate continuously due to various factors such as a country’s economic power. Forex traders are looking to take advantage of these fluctuations by speculating on whether prices will rise or fall.
All forex pairs are quoted in terms of one currency against another. Each currency pair has a “principal”, which is what the first currency is called, and a “counterparty”, which is what the second currency is called.
Each currency can be strengthened (appreciated) or weakened (depreciated). As there are two currencies in each pair, we essentially speculate on four variables in forex trading.
If you believe that the value of one currency will rise against another, you put on long or “buy” that currency. If you believe that the value of one currency will fall against another, you shorten or “sell” that currency.
So for example, if you thought the USD would strengthen (appreciate) against the JPY, you would get long or buy the USD/JPY. You would also buy if you believed that the JPY would weaken (depreciate) against the USD. On the contrary, if you thought that the JPY would strengthen against the USD, or that the USD would weaken against the JPY, you would sell or short of USD/JPY.
For all these factors, the forex market offers you infinite possibilities every day, hour, even every minute.