Forex is short for Foreign Exchange. Different countries use different currencies, and they can be traded. FX as its popularly written allows customers to buy, sell and exchange currencies of their preference at prevailing market rates. Some currencies enjoy more popularity than others and are traded more. The value of a currency fluctuates on a daily basis.
Currencies are traded in the Forex market. It is a global decentralized market where currencies are traded daily. There is a need to exchange currencies which have led to the flourish of the business. Foreign trade and businesses need to exchange currencies. Even travelers or students who move to other countries need to pay in the currency different from their own.
The Forex market is one of the most liquid financial markets in the world, larger than even the stock market. Traders do not perform their functions in a marketplace unlike other forms of trading. It is usually done Over-The –Counter using computer terminals. This market remains open five and a half days a week and various currencies are traded across important financial centers of the world such as Hong Kong, London, New York, Tokyo, Singapore, etc. across different time zones. Due to this nature of the forex market, the price quotes keep changing continuously.
The exchange prices vary based on a wide range of factors, both economic and political. Any incident in any of the sphere has the potential to affect the movement of currencies. However, the main drivers of the currency fluctuations are the interest rates, inflation, and political stability. Often Governments may jump into the forex market to manipulate the prices of currencies. They do this for economic and political reasons mostly. But the market is too huge for any one reason to have an altering impact though recently China has seen its government interfering to devalue the currency which has had a financial repercussion on other countries’ markets as well.
Currencies are always traded in pairs since we are “exchanging” currencies. Examples are such as EUR /USD / CHF, GDP, EUR / JPY, etc. Very often traded pair is the USD-Euro and Japanese Yuan and USD. There are various ways in which currencies are traded. The underlying thought behind any business transaction is always to make a profit out of it. There are three types of Forex trading that happen:
The first two are short term in nature, and the last one is long term. Each has a purpose to serve and is meant to suit different investor needs or even suit the same investor’s different needs.
1. Day Trading: In this type of trading, the investor trades currency in a short term, the term here being a day in the hope of making profits. Intra-day investors close the trade by the end of the day with whatever profit or loss they have made. They make quick money from small movements in the currency and avoid taking risks associated with overnight movements in the currency market.
2. Swing Trading: In this type of trading, the investor doesn’t trade long term, but the time-frame may vary, usually stretch for more than a day. It is done to take advantage of quote swings. The time frame may also vary from an hour, a day or maximum a couple of days. The risk in holding for longer duration is higher and so is the profit margin.
3. Positional Trading: This is a long term trading method, and the trade is held for longer durations such as a couple of days, weeks, or even a month. This form of trading requires the use of both fundamental and technical analysis to select an entry and exit point for the pair chosen. There are different levels of risk associated with holding the position for a longer duration, and the expected gain is much larger too. While trading requires an understanding of certain fundamentals of the forex market, these are certainly delved into by both beginners and experienced. Practice and experience bring in perfection.
Forex is traded in three main ways: the spot market, the forwards market, and the futures market. Individual traders, corporations, and others use the spot market to trade. Though in the past the futures market was more frequently traded, it is the spot market that has captured the imagination of the individual investors. These days, by forex market, people mean the spot market. Companies and organizations that need to hedge their foreign exchange risks to a certain specific date in the future use the forwards and futures market.
In the spot market, currencies are bought and sold based on their current price. The traded rate is dictated by the supply and demand and reflects the market sentiment apart from other factors such as economic performance, current interest rates, speculation about the future performance of one currency viz-a-viz the other. Spot deals take place wherein the parties involved are in a contract to deliver the said amount of one currency and receive in exchange another currency of a specified amount at the agreed upon rate. The settlement is made in cash and takes a day or two to happen. As the names suggest, the forwards and futures market do not go by the current market price. Here, contracts are made that represent claims to a certain currency type, a specific price per unit and a future date for settlement.
In a forwards market, a contract is agreed upon by the involved parties and bought and sold in the market. In a futures market, futures is sold and bought based on a standard size and a future settlement date. Futures are sold on a public commodities market. In the US, this market is regulated by the Nationals Futures Association. The futures contracts have a specific date, a number of units being traded, delivery and settlement date, and minimum price increments – these specifics can’t be altered. Upon expiry they are settled for cash and the terms are binding. But futures and forward contracts can be bought and sold before they expire.
These types of contracts offer protection against the risk of currency fluctuation. Large corporations make use of speculations in the market to hedge their funds against future exchange rate movement.
The forex market presents a chance for profit - both in succession and growth rates. But as in any trade, there is an uncertainty factor. Large movements occur within a day, and this presents an opportunity for traders to make gains. However, there is a chance of loss too. Traders who are new to the market should use the services of a broker or broking agent.