What is Forex ?
What is Forex Trading and How Does It Work?
You may have heard the word “Forex” (or “FX”). It is an abbreviation for “foreign exchange,’ which involves the trading of one currency for another. That is,the selling of one currency and the buying of another.
Naturally, to buy any item, you have to pay for it in a currency. However, things can start to get complicated when what you want to buy is not an item but another currency. For instance, assuming as an Indian who wants to embark on a business trip to Manc hester, UK. So, you own the Rupee (Rs), which you can’t get to spend in the UK.
Hence, you have to get the British Pound (GBP), making use of your Rupee (Rs). The forex market is the financial market where you can do this.
The Forex Market
The forex market is the avenue where the exchange of currencies occurs. Unlike other financial markets, there is no single location for this market as it is mostly decentralised and mostly transparent. That is, there is no central exchange for forex trading.
In an increasingly globalised world, companies cannot source all their inputs within their countries. So, they have to look to other markets. To, however, facilitate those trades, they have to make use of forex. Although they participate in the forex market on a lesser level to hedge the risks associated with currency transactions, some, however, do it for profit purposes.
Individuals and Retail Investors
Individuals, known as retail traders, also participate in the forex market for business and personal reasons. However, there is a fast-growing number of retail traders who trade the market for profit. Trading the forex market is particularly attractive to retail traders due to many reasons, which include:
– It is very liquid
– It is available for trading almost all around the clock.
To speculate correctly, individual traders make use of a combination of fundamental and technical analysis.
However, the forex market has two tiers. First is the Interbank Market, where the big banks trade and exchange currencies with each other. There is then the Over-the-Counter (OTC) market, where trading is done between parties, rather than with the banks.
As a result of its decentralization, the forex market is open 24 hours a day throughout the five working days of a week.
Why the Need for Forex Trading
Why is forex trading necessary, and why is it such a big deal? The world is a global market. We do not produce most of what we need in our own countries. Thus, we have to look to other countries that make such things to buy from.
However, to make the purchase, you need to do so in the other country’s currency. There are over 180 currencies in the world. So, you need to convert your country’s currency to another’s at a figure called the exchange rate which continually fluctuates. The same scenario plays out when you embark on international travels for business and pleasure, send money to loved ones overseas or pay for a subscription service provided by an international company.
That is you trading forex on a smaller scale. Companies of various sizes also engage in this to source critical goods from other countries for their business. This never-ending exchange of currencies creates the largest financial market, with an average turnover of $6 trillion daily, also making it the most liquid.
Key Participants in the Forex Market
Daily, several organisations and individuals engage in the trading of currencies for different purposes. They include;
Central banks are responsible for the issuance of their respective countries’ currencies. They participate in the forex market to stabilise or boost their economies.
The Big Banks:
Perhaps the largest players, massive investment and commercial banks participate in the market to execute forex transactions for their clients. They also do it for speculative and profit purposes.
Fund and Asset Managers
Fund managers (especially hedge funds) trade forex mostly for profit purposes. Most investment managers trade foreign securities (equities, bonds), and they have to do this in foreign currencies. Also, they directly make speculative trades on the forex market for profit.