What is forex trading?
Posted on 24th Oct 2017
To put it very simply, Forex Trading or the Forex marketplace is where buying/selling transactions of various currencies or assets takes place between investors, retail forex traders, banks, governments, hedge funds and companies. Just like in any other form of speculation you buy something at a specific price and want to sell it at a higher rate in order to register a profit. Forex is also referred to as the FX market, currency market, foreign exchange market and the foreign currency market. Forex Trading has gained huge popularity over the last few decades or so. It is the largest financial market worldwide owing to its high liquidity and has a trading volume of USD 5.3 trillion daily. Also, it is a market that operates 24 hours a day and 5 days a week from 5pm EST on Sunday till 4pm EST on Friday.
Forex rates are quoted by all the major banks; however, all banks do not have the exact same rates for them. The various brokerages take the various quotes from these banks and they in turn give us an estimated average of them. Thus, these brokerages also act as market makers for us.
A brief history of forex
In the year 1876 a system known as the gold exchange standard was put into place. As per this system all paper currency had to be backed by solid gold. The idea was to stabilize currency rates based on the price of gold. It was not practically feasible as it led to boom and bust patterns resulting in the discontinuation of the system around the time of World War 2. Yet gold continued to be the ultimate form of monetary value. Nations then decided to have fixed exchange rates and the US dollar was considered to be the primary reserve currency and the only currency to be backed by gold. It was called the Bretton Woods System and came into effect in 1944. However, in 1971 the US declared that it would no longer exchange gold for US dollars and the Bretton Woods System became obsolete. Following this in 1976 floating exchange rates were introduced which was the beginning of the present-day currency market. However, it was only since the mid-1990s that currencies were extensively traded electronically.
Following are a few salient features of the FX market:
Over-the-counter market:
There is no designated physical marketplace for forex trading. Rather it is an over-the-counter market wherein transactions are not executed via a centralized exchange. This is in contrast to other markets e.g. the stock market where there is a central marketplace through which orders are processed like the NYSE. Thus, forex investors in any part of the globe can immediately react to changes in rates as a result of political, social and economic occurrences. Due to the high volatility there is never a lack of buying or selling opportunities at any given point of time.
Open 24 hours:
There is no downtime in the forex market with transactions happening 24 hours a day and 5 days a week. The most important financial nerve-centres are located in London, Tokyo, Sydney, Hongkong, Zurich, Frankfurt, Paris and New York. The forex markets are spread all over the globe and thus follow a 24-hour global timetable.
High liquidity:
The forex market offers the maximum liquidity as it is easily accessible to any number of buyers & sellers and constitutes the highest trading volume.
Long/short positions:
Investors can easily take long/short positions in the currency market. If you think a currency/asset will go up you can buy it at once and take a long position. On the other hand, if a currency/instrument depreciates in value you can short it or sell the same. Thus, there is nothing like a bear market in forex.
Global exposure:
As the world has become a global village, today's investors are willing to put in money wherever they can spot an opportunity. Forex Trading enables them to invest in any nook and corner of the world without having to face any impediments like foreign securities legislations or financial statements in some unintelligible language.
None can manipulate prices:
The forex market is so vast and has such innumerable participants at any given point of time that it is next to impossible for anybody (even a central bank) to control prices for long.
Leverage:
In forex trading you can enter into a much larger trading position with a minimal deposit through the use of Leverage. However, it is to be noted that leverage is a two-way street and can enhance your gains as well as losses. Thus, before trading in the currency market it is important to carefully asses both the risk as well as the reward.
Easy to get started:
It is a common perception that being a forex trader involves a lot of money. However, contrary to popular beliefs, nowadays a lot of online brokers also offer micro and mini trading accounts. Thus, even the average Joe without substantial start-up capital can trade forex.
Low transaction costs:
Most brokerages in forex trading earn their profits through the retail transaction cost or the spread which is generally less than 0.1% under normal market conditions. There is no government fees or exchange fees to be paid.
Demo trading accounts:
Most online brokerages nowadays offer clients with free trial accounts whereby the latter can finetune their skills in a virtual environment before risking actual money in the market.
Thus, forex trading offers anyone with limitless opportunities to earn profits. Many people venture into the market considering only the benefits and ignoring the underlying risks. Notwithstanding that anyone with enough determination, discipline and risk management skills can become a successful forex trader.
