What is Forex

By: EconomyWatch   Date: 27 July 2009

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EconomyWatch

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Foreign exchange (Forex) is a type of financial trading in which the currency of a country is exchanged for that of another. With a daily turnover of over $3.2 trillion, foreign exchange is the largest financial trading market in the world. The major centers where the majority of the dealings take place are Sydney, Tokyo, London and New York.

 

The forex market started evolving in the 1970s when international trade switched from a fixed rate (set by the Bretton Woods agreement) to a floating exchange rate. Since then, the relative rates of currencies have been determined by buying and selling activity within the international foreign exchange market. When more of a currency is bought, its relative price goes up, and when more is sold its price goes down.

 

Forex: How it Works

Contrary to other financial markets, the forex market has no central exchange or physical location. Banks and brokerage companies are connected over the Internet, enabling a 24-hour functioning of trading operations across the world.

 

Traders analyze trends in the movement of currency prices to make buy or sell decisions that yield high returns. Profits or losses are made in forex with the rise or decline in the value of an investment, caused solely by movements in currency rates. For example, a forex trader, anticipating the weakening of the US dollar, may buy Euros. This investment would yield profits when the Euro strengthens against the US dollar.

 

The most traded currencies are those of:

  • nations with stable governments

  • central banks targeting low inflation

Benefits and Dangers of Forex Trading

Forex trading has the following advantages:

  • Round-the-clock operations: The forex market, being worldwide, is open 24 hours a day. This facilitates traders in making their own trading schedule.

  • Liquidity: Large amounts of money can be moved with minimal movements in currency prices.

  • Low Transaction Costs: The transaction cost is built into the currency’s price. Known as spread, it is the difference between the prices at which the currency is bought and sold.

  • Leverage: Traders can trade more money than what is present in their account. One can trade $100,000 with just $1,000 in his or her account at a 100:1 leverage.

 

High leverage, at times, can be dangerous. High stake positions are exposed to high risk. Also, the market being active all the time makes it difficult for individual traders to keep track of movements in the forex market.

 


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