Of all the financial markets, the forex market is perhaps the least well understood, and yet it impacts us all every single day of our lives, in a myriad of different ways. Whatever we buy or sell, no matter how small or incidental, will in some way have been influenced by what we call the forex market, or more accurately foreign exchange.
Perhaps the simplest and most visual example is when we travel abroad. The first thing we do, either at the airport or before, is to change some of our own currency to that of the country where we are traveling. If we are in Europe and traveling to another European country, then this is less of a problem since the introduction of the so-called ‘single currency’, the euro. A German traveling to Italy has no such worries since both countries use the same currency. But once he or she travels to the UK or the USA for example, then euros need to be exchanged for US dollars.
This is the principle of the foreign exchange markets, and the small electronic boards that you see at international airports, are simply visual reminders that currency exchange rates affect us all. Whether we are traveling, buying products from overseas, using base commodities such as oil and petrol, or consuming imported foodstuffs, all are subject to and influenced by, foreign exchange rates between countries around the world.
Every country in the world has its own currency. It is the quoted exchange rate of one country’s currency against another, which is the simple principle on which the forex market is built.
Now, I make no apology by starting with the basics, as these are the building blocks of your knowledge, so let me begin by answering the five most asked questions in forex trading which are as follows:
- What is forex trading?
- Why do we have a forex market?
- Who are the main participants?
- How are prices derived?
- Where do I fit in?
What Is Forex Trading?
Forex trading is short for foreign exchange trading and, represents the market in which one country’s currency is quoted against that of another. It, therefore, provides the basis for anyone in the world, from governments, companies and private individuals to agree on a rate of exchange between one currency and another. Without these market rates being quoted, parties wanting to exchange their currency would be forced to agree on a rate for each transaction on an individual basis. In other words, there would be no agreed standard by which to set these rates.
An interesting feature of the forex market is that it has no centralized exchange, such as in stocks or futures. As a result, all trading is conducted over the counter (OTC), which simply means that it is not conducted in a regulated environment, and indeed is often referred to as ‘off exchange’ trading. The forex market allows businesses, investors and traders to take advantage of the change in currency rates by taking a view as to the likely future direction of one currency, relative to another. As a result, all currency rates are quoted in pairs, with one country quoted against another.