What is Forex and How does it Work

Forex Market is the largest and most dynamic financial market. Let us discuss what forex is and how it works to help you understand the basics of trading.

Forex Market is the largest and most dynamic financial market, with many participants and high returns. You can make a good amount of money while trading forex. However, if you want to start your trading career with the foreign exchange market, it is essential to have a greater and better understanding of its basics. In this article, we will have a detailed study of what forex is and how it works.

What is Forex?

Forex is a short form of foreign exchange. It is the process of exchanging one currency for another for buying and selling goods and services, traveling, trading, etc.

The main aim of foreign exchange is to facilitate global exchange efficiently. Earlier barter system was there where one commodity was exchanged for the other.

However, finding the right buyer or seller willing to take or give what you want was complicated. So after this, coins of bronze, copper, gold, or other metal came into existence and started using as a medium of exchange.

These metal coins were then replaced by paper currencies, today known as forex currencies. Central banks of the countries issue these currencies to provide their people with an efficient exchange system.

You can buy or sell any good or service using these currencies in the country. However, what if you want to buy or sell goods and services in any other nation?

That’s when a foreign exchange or forex came into existence. Globalization gives birth to foreign exchange. People started exchanging currencies to consume the goods or services of other countries.

The most important aspect of foreign exchange is that all the currencies have different values based on the respective country’s economic, financial, social, cultural, and technological structure.

What is the Forex market?

Forex Trading is the process of buying and selling currencies, and the Forex market is the place where buying and selling of currencies takes place.

As we have studied above, a currency’s value keeps changing due to different factors. Traders, in order to take advantage of their price fluctuation, invest in these currencies.

Under forex trading, Trader buys a currency when they feel its value will rise and sell it in the opposite case.

Let us have a look at forex trading examples. Suppose you live in Britain, and at present, one US Dollar is equal to 0.78 Pounds.

At this rate, you have bought 100 US Dollars for 78 Pounds. After some time, the value of USD rise against Pound, and now one USD dollar is equal to 0.90 Pounds.

So, you decided to sell 100 USD. Now you will get 90 Pounds which means you have made a profit of 12 pounds in this case.

In the above example, we have seen how a forex trader makes money. Let us discuss the key features to understand better what forex is and how it works.

Over the Counter

Forex market is the largest financial market where daily more than $ 6.6 trillion transactions occur, and that too over the network of computers.

FX market is also known as the over-the-counter market because all transactions occur electronically from anywhere at any time.

No central exchange

In stock market, the activities are regulated by a central authority like New York Stock Exchange or London Stock Exchange based on the geographical location.

However, in the forex market, no central exchange or physical location that regulates or controls its activities. You can trade in currencies using different forex trading platforms.

24/5 Market

Foreign exchange is a 24/5 market which means traders can trade in forex anytime from anywhere except on weekends. There are four major sessions, including London, New York, Tokyo, and Sydney in forex.

At any point in a day, at least one session remains open, and you can trade in any session, irrespective of your location.

Market Participant

Many big organizations and individuals participate in foreign exchange for different reasons. That’s why the fx market offers great liquidity and volatility to traders.

Central Banks, Large commercial banks, investment banks, multinational companies, hedgers, and retail investors are the major forex market participants.

Market Factors

A stock is a representation of a company. Similarly, a currency is a representation of a country. Therefore, changes in a country’s political, economic, geopolitical, natural, and social status have a positive or negative impact on a currency.

Traders keep a watch on these fundamental and technical analysis factors to identify when, how, and where to buy or sell a currency.

Ways to trade in Forex Market

We have understood what forex is and how it works. Now let us discuss how to start trading in forex.

Spot Market

The first in the list is spot trading, where currencies are bought and sold for immediate delivery or on the spot. The government, large banks, and investors take part in the market.

Currencies are traded at current market prices. Traders take advantage of price movements of seconds or minutes. Generally, in the spot market, delivery takes place within two trading days or 48 hours.

Forward Market

Under this, two parties are agreed to buy or sell currencies at a predetermined price at a specified date. The currency pair exchange rate is also fixed when traders enter into a contract.

The market allows investors, businesses, organizations, and other market participants to hedge currency risk.

Futures Market

It is quite similar to the forward market as under this, currencies are traded on standard contracts containing details of length unit and maturity date of trade.

However, these contracts are more regulated and occur on the exchange platform. Also, the terms are fixed when entering the contract and are not changed or customized in the future.

Wrapping Up

The Forex market offers a great environment to make money from trading. There are more than 15 million traders and 180 legal currencies to trade in the world.

However, trading requires knowledge, skills, discipline, patience, and effective decision-making. Learning before earning is the most important rule of the forex market.

No, doubt you can make good money in the market, but the chance of losses is also there. Having a clear understanding of what forex is and how it works enables you to trade efficiently.