What is the Forex Market?
Forex is acronym of Foreign Exchange. It is also referred to sometimes as “FOREX” or “Forex”, “Retail forex”, FX, “Spot FX” and “Spot”, but it is most commonly known as Forex or forex.
Forex is, actually, an abbreviated version of the words Foreign Exchange and is the act of trading currencies from different countries against each other, put more basically, buying and selling currencies with the intention of making a profit from the difference.
Of course there is more to it than that and there are rules and methods to the practice.
Forex is a 24/7 market which is to say, the market never sleeps. It is operating somewhere in the world every minute and there is no opening or closing time, so the forex trader can start and finish his trades at any time. Forex trading has now reach the staggering volume of around 3 billion dollars a day. A few of the participants in this market are simply looking to exchange a foreign currency for their own, Examples are the multinational companies who need various currencies to conduct their business in different countries. But the vast majority of are there specifically to trade currencies and speculate on the movement of in the various exchange rates and take advantage if even the smallest fluctuation in exchange rates between currencies.
How Forex Works
Every market in the world has a bid and offer. Whether trading cows for goats in the depths of Africa or in the locals retailers where a bargaining position is occurring, to trading stocks and shares on the traditional stock markets and also in the forex market.
One person makes a a bid or puts up a price and another person makes an offer and when the two agree you have a sale or exchange.
The forex market is more sophisticated of course than the local market place where one might offer a sum of money for an item and then haggle with the seller until an agreement is reached. In the forex market it is done very fast and, with the sophisticated software now available to anyone who wishes to dip their toe into the market, trades in the forex market can be very fast and furious and almost fully automatic.
In the forex market the differences between the bid and the offer is tiny, fractional almost and the reliance is on quantities of these bid/offers, occurring very fast to make money.
Useful to know is the fact that there is no insider information in the forex market. There is also theoretically no way any one participant can ‘corner’ the market, as it were. Exchange rate fluctuations are generally caused by monetary flows and changes in the economic conditions of the various countries. Any news that might affect the currency of any one or more countries is released simultaneously around the world so that everyone trading can receive the same news at the same time. Profit is made, not on predicting the trend of a currency against another but on the minute fluctuations occurring 24 hours a day, seven days a week.
One of the advantages of trading in the forex market is that there are no dealers to pay. One trades through a broker, also called a market maker, who sends the order to their partner in the Interbank Market where forex trades actually take place. This is called filling the position. When you decide to close your trade, again you pass this along to your broker and he closes your position on the Interbank Market and you are then credited with any gain or debited with any loss from that trade. This usually happens within seconds, and you can conduct hundreds of these trades within an hour or trading spell. In e-forex trading, one is using software to conduct ones trades for one. One sets the various parameters or rules, if you like, as to what you want to trade, how long, when to stop or start and other criteria and the software does the rest.
Currencies are traded against each other. This is done in pairs. The reason they are quoted in pairs is because in currency trading you are buying one currency and selling another and each currency must be shown in this transaction. Each pair of currencies is expressed as a ISO 4217 international three-letter code of the currency into which the price of one unit. AA common example would be EUR/USD. So this would be the price of one euro expressed in US dollars. Example. 1 euro = 1.4957 dollars.
During the course of a few seconds this ratio can change. The dollar value of the euro may increase, or decrease.
So in the forex market the bid/offer spread, is the difference between the buying price and the selling price, On major currency crosses, the difference between the price at which a market maker will sell (“ask”, or “offer”) to a wholesale customer and the price at which the same market-maker will buy (“bid”) from the same wholesale customer is minimal, usually only 1 or 2 pips. In the EUR/USD price of 1.4957 a pip would be the ‘7’ at the end of the USD price. So the bid/ask quote of EUR/USD in this case might be 1.4237/1.4238.
This is not the same as you going down to the bank or a currency exchange service at the airport. You will see a much bigger difference between the currencies. There the difference is the cost and mark up of the bank or currency exchange service and this is weighed heavily in favor of the bank or exchange service regardless of what exchange you wish to make.
In most trades on the forex however, a speculator will trade, using a broker who will have a spread (The difference between the bid and offer or ask prices) mark up anywhere between 3 and 20 pips.
A margin is essentially funds deposited as collateral to cover any potential losses from adverse movements in prices.
Where it is vitally important to understand what one is doing in forex trading lies in the fact that brokers will give their clients hugh margins in order to give their clients more leeway to spend more money on each order. Brokers are not regulated by the US Securities and Exchange Commission, since they are not selling securities, and therefore not bound by the same regulations and, importantly, same margin limitations stock brokers are. Also they do not charge any ‘margin interest’ as all currency trades must be settled within 2 days.
An example of this is where a speculator wants to trade 50,000 dollars on the forex. Say he thinks that the euro is going to go high on the dollar. It is not necessary to cough up the 50,000 dollars to start with. His broker will accept 250 dollars and put in his order for 50,000 dollars. If the order goes in his favor he will make the profit as if he put in the entire 50,000 dollars. If he sustains a loss then the broker will make a margin call to the trader. This is a request by a broker or dealer for additional funds or other collateral in order to guarantee performance on a position that has moved against the trader.
If a succession of trades goes against the trader and the broker calls for funds to make up the difference. On 50,000 dollars this can often mean the trader will lose his short. And it has happened many times. So it is important for a forex trader to really understand what he or she is doing when playing in the forex market.