What Is Forex Trading?

“Forex Trading” is the common name given to the foreign exchange, or for.ex, market. Forex trading has become one of the fastest-growing forms of investment from 2004 to the present, full of both opportunties and perils for the investor. The Forex Market or “foreign exchange market” is a 24 hour market where currencies of the world’s nations are traded. Foreign currencies are continuously being bought and sold across the Forex market by banks, brokerage firms, and individuals. As these currencies are traded, global markets and investment values increase or decrease in value based upon the movement of the currency. Similar to the stock market, the value of global currencies can change depending on real world events.

The need for nations to exchange currencies is the primary reason for the Forex market. The Foreign Exchange Market is the largest financial market in the world, larger than even the New York Stock Exchange and similar stock markets in other countries. Most nations have vast numbers of banks and investment firms, corporate buyers and sellers. These currency institutions all do business on the Forex market. A unique aspect of the market is that there is no central marketplace to conduct business. You do not have to get dressed and go somewhere in order to trade. All currency trading is conducted electronically via computer networks between traders all over the world. The market never closes, so you can go online at any time of day or night and trade currency. Since all the major financial cities such as New York, Zurich, and Tokyo are all in different time zones, there is always a lot of activity going on at any time. That means you can get a night’s rest and wake up to new foreign market conditions.

History Of Forex Trading

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At the end of World War II, the Western nations helped to create the Bretton Woods Agreement. This agreement set the exchange value of all currencies in terms of the U.S. dollar. At the time the U.S. dollar was set to the current gold standard, which was $35 per ounce. Since the global economy after the war was in such turmoil (Europe in particular), the goal of the agreement was to help stabilize the world economy as a whole and avoid the political and social turmoil (and revolutions) that followed World War I. This worked well for a generation, but the global economy changed and the agreement became outdated and restrictive.

After years of speculation that it would happen, the Bretton Woods Agreement was ended in 1971 and the foundation of today’s currency market was established, with the United States in the lead. The currency market continued to evolve, but the arrival of the internet allowed for a much more rapid way for the foreign exchange market to conduct business. Suddenly, currency trading was so much simpler. Also, the increased practice of depositing U.S. currency in foreign banks helped to stimulate the Forex market. Today, the Forex market averages over $3 trillion a day in transactions.

What Is The Forex Market

The Forex market works basically like this. You purchase currency from one nation and use currency from another nation to pay for it. Where your profit comes from is from the difference in value of the currency, which occurs when their are inefficiences in the way currency pairs are figured. This is your return on your trade. The process of making money by exploiting an inefficiency in the exchange price of two currencies is called “Forex arbitrage”. Arbitrage traders actually help correct the market by exposing these inefficiencies and make a nice sum of money doing so. Forex arbitrage situations are usually quite temporary, and a forex trader must have real-time forex market numbers and the computers to calculate Forex inefficiency to take advantage of this temporary arbitrage situation.

Here is an example. Let’s say you decide to buy the European dollar. You will need currency from another nation to do it so let’s say you use the American dollar for the purchase. If you purchased the Euro dollar with an American dollar and then the value of the Euro dollar went up in comparison to the American dollar, then you wind up making a profit, simply because your currency is worth more. Simple, right? But you only make a profit if the currency goes up. Otherwise, if it goes down in value, you end up losing money. Forex Trading is a zero-sum game. That is, trading is like a mathematical equation: both sides of the ledger must cancel out. If you make a million dollars in Forex arbitrage, someone else must lose a million dollars. This means you have to be on top of your game when trading in the Foreign Exchange Market.

How To Trade on the Forex Market

There are actually three ways that banks, corporations and individuals trade on the Forex market. There is the spot market, the forwards market and the futures market. The spot market is where currency is bought and sold at its current price. The spot market always has been the largest of the three markets. The forward and futures markets deal in contracts that represent claims to a certain currency type, a specific price per unit and a future date for settlement. The futures market used to be the most popular market, because it was available to individual investors for a longer period of time. But the rise of electronic trading changed all of that. Most of the time when someone refers to the Forex market, they are actually referring to the spot market. The forwards and futures markets are the preferred markets for some companies that need to hedge their foreign exchange risks out to a specific date in the future.

Reasons For Trading on the Forex

Trading on the Forex market comes with many benefits. The main reason is that, unlike the stock market, the Forex market conducts business 24 hours a day, seven days a week. It never shuts down, never closes, and can always be accessed. The Forex market is a 100% liquid market that makes trading currency extremely easy. They are no assets that one has to sell before they can trade. It is already broken down into cash.

Forex Trading Volatility

Another benefit of Forex trading is that the market is highly volatile. This means that it can rise and fall very quickly, offering profits within minutes of trading or you can lose all of your money just as quickly. The good news is that experienced traders have tools available to them, such as software, to minimize the risk. This allows you to have the ability to still make a profit even in a falling market.

How Is Forex Different From Trading Stocks

While trading on the Forex may seem a lot like trading in stocks, there are some significant differences. Because of these differences, traders intent on making purchases on the Forex need to try a different approach than the one they would normally use for other markets.

The main difference is the time-frame. The Forex market never closes. There is always activity during the week, due to differing time zones and even on the weekends as well. Some specific markets may be open 24-hours, but due to the fact that most traders in that particular region are going to be resting, their volume at any other time but during the day is very low.

There are also no exchanges in Forex trading. Futures is sort of like a form of “exchange”, but most of the transactions these days takes place on the spot market. Large Forex transactions are done by banks trading with each other on behalf of their customers, or even corporations dealing in trades of up to several million dollars. When individual traders conduct transactions on the market, often they go through a broker.

Since there is no technical exchange in the Forex Market, there is a difference in how trading is actually done. In the stock market, an order is submitted to a broker, who makes the trade with another broker or even through an exchange. In the spot market of the Forex, most of the trading is actually done directly with a broker. That means the broker is the acting second party in the trade. There is no middle man.

Finally, when dealing with brokers on the Forex market, they often do not charge a brokerage fee like they do in the stock market. The broker instead is going to make his profit by turning around and making the spread between the bid and offer prices – calculating the spread between the two down to the lowest fraction is called “pips”.

Before Trading On The Forex Market

Even though all of this may sound simple, there are some things to be aware of. The Forex market may be open to anyone with Internet access, but before you log on to trade you should learn how elements such as a country’s monetary policy, trade policies, and world news can affect exchange rates. An experienced trader will have a good understanding of the technical side of trading, have some proven strategies, and ways of minimizing risk. If you have never traded on the Forex before, a reputable broker is a must. Always go with a broker who is backed by a major bank.

Qualified brokers will provide real-time quotes and operate with good trade execution software. In the U.S., you can choose a broker who is a certified member of the National Futures Association to conduct your business. Beware of “forex scams” and brokers who charge a fee. If you are charged a fee for your Foreign Exchange Market transactions, that is a sign the broker isn’t confident in his ability to make money from pips. Beware of forex brokers who promise unbelievable sounding windfalls, too.

Besides Forex scam artists, you need to be aware how quickly the currency market can rise and fall. The Forex market can suffer quick and severe changes within just a few seconds based on real world events. For example, war has always been a major factor is currency rates. When there is the threat of war, it can have an immediate effect on the Forex market. This is just the volatile nature of the market that makes it so risky and can be a good way to lose all of your money if you are not careful. At the same time, the market volatility of Forex trading makes it possible for the wise Forex trader to make a lot of money in a short period of time.