Everything you need to know about Forex

The foreign exchange market, currency market or Forex is the market on which one currency is traded against another. It is one of the largest markets in the world. Some of the participants in this market are simply trying to exchange a foreign currency for their own, such as multinationals that have to pay wages and other expenses in other countries where they do not sell products. However, a large part of the market consists of foreign exchange traders speculating on exchange rate movements, much like others would speculate on share price movements. Foreign exchange traders try to take advantage of even small exchange rate fluctuations.

There is little or no “insider information” on the foreign exchange market. Exchange rate fluctuations are usually caused by actual cash flows and expectations of global macroeconomic conditions. Important news is publicly announced, so that – at least in theory – all people in the world receive the same news at the same time.

Currencies are traded against each other. Each currency pair thus represents an individual product and is traditionally referred to as XXX/YYYY, where YYY is the international three-letter code according to ISO 4217 of the currency in which the price of a unit of the currency XXX is expressed. For example, EUR/USD is the price of the euro, expressed in US dollars, as in 1 euro = 1.2045 dollars.

Unlike stock and futures exchanges, foreign exchange trading is indeed an interbank, available for sale (over-the-counter) market, which means that there is not a single universal exchange for a particular currency pair. The forex market works 24 hours a day throughout the week between individuals with Forex brokers, brokers with banks and banks with banks. When the European session ends, the Asian session or the US session begins, so that all world currencies can be continuously trading. Traders can respond to messages when they break, rather than waiting for market opening, as is the case with most other markets.

According to the BIS’ three-year report, the average daily international foreign exchange trading volume in April 2019 was USD 6.6 trillion.

As in any market, there is a money-letter range (difference between purchase price and selling price). For the main currency pairs, the difference between the price at which a market maker sells to a major commercial customer (“Ask” or “Offer”) and the price at which the same market maker buys from the same wholesaler (“bid”),is minimal, usually only 1 or 2 pips. At the EUR/USD price of 1.4236, a pip would be the “6” at the end. The EUR/USD money/letter rate could therefore be 1.4238/1.4239.

What is Forex?

Many wonder what Is Forex Actually? Now Forex is the most used abbreviation for “foreign exchange”, i.e. the price of one currency in relation to another currency. By definition, all Forex prices refer to the relationship between two currencies, i.e. a currency pair.

The term “Forex” is used interchangeably with the term “FX”. Both are used today, and both relate to the same thing, namely foreign exchange. Professional traders in the US, at banks and brokers, tend to use the term “FX”, while “Forex” is the term adopted from British parlance for the retail market. The word “currency” is also used, as in “I trade with currencies” or “something has happened on the currency market”.

The terms “trading forex” refer to currency trading on the foreign exchange market. Forex can be described as this; a matter of monetary value is given in return for another thing of supposedly equal value. The word “trade” refers to the transaction in which each of two parties is willing to exchange their respective money basket for the corresponding amount of money in the second currency. The price at which the two parties are willing to exchange is the exchange rate.

The price of a currency in relation to another currency is referred to as “price” and not as “price”, although the word “price” is equally valid and often used. The foreign exchange market is the only market where the word “price” is used instead of the word “price”. The reason for this use is probably because the word “price” has been used since the Middle Ages as a term for a customs or tax charge, since the conversion of one currency into another currency means the application of one ratio or share of one currency in relation to the other. A common Latin phrase is “pro rata” of “pro rata parte”, which means “in proportion”. The word “rate” in English derives from the Latin “rata”.

What is exchanged for Forex-trading?

Since Forex refers to two money baskets, each with its own face value, forex trading can be as simple as buying a basket of 165 dollars for the equivalent of 100 pounds at an airport kiosk. The exchange rate is 1.65 dollars per British pound sterling.

Why isn’t the exchange rate at .6061 per dollar? This is the same exchange rate, just in other words (it is the inverse or 1 divided by 1.65). The answer lies in the historical convention of specifying the price of other currencies in pounds, which they cost in pounds. Sterling was the reference currency for centuries until shortly after the Second World War, i.e. the central currency used to value and price all other currencies.

After World War II, the US dollar became the reference currency, and most other currencies were valued according to how many units of the foreign currency could be obtained for one dollar.

As a rule, any money that is not spent by your home government is “foreign”. The natural way to look at foreign exchange is to ask: “How many units of foreign currency can I get for a fixed amount of my home currency? This is how a tourist or importer looks at foreign currency. But since the dollar is currently the reference currency against which almost all other currencies are valued, the dollar is the top destination on behalf of many currency pairs, though not all. The first name in a currency pair is usually the important name and the second is the second important or less important one.

Putting a name first assumes that the fixed amount is that currency and that the variable amount will be the other currency. In other words, the first currency is the base and you apply a ratio to derive the price of the second currency. When the European Monetary Union decided to write the euro in the euro/USD and euro/JPY formats, etc., it was a conscious decision to make the euro the more important of the two currencies in each pair.

The rule is that the name first mentioned becomes stronger at higher numbers and weaker at lower numbers. If the figure in the pound rises, e.g. from 1.6000 to 1.6500, this means that the pound will become stronger and the dollar will weaken, because in this pair the full quotation should be GBP/USD. It is right to put the quotation as 1,6000 to 1,6500 dollars, i.e. the pound used to cost ‘1,6000, now it costs ‘1,6500. Journalists usually apply the convention to put the dollar sign before the price offer, although brokers and analysts tend not to insert the currency symbol.

This also applies to the euro (EUR/USD), so a higher figure always means that the euro is stronger against the dollar. One could say that the EUR/USD has risen from 1.3200 to 1.3900, which means that it has become more expensive in dollars. If you are new to the Forex market, you can precede the former currency with an imaginary currency symbol to orient yourself. As a result, the price quotation now looks like 1.3200 to 1.3900 dollars.

What exactly is Forex trading?

If you go back to the kiosk at the airport to exchange your home currency for another one, don’t trade. You are a price-taker. The sign at the kiosk tells you which exchange rate is applied, and you stick with it. You can take it or leave it.

This is not Forex trading. Because trading is the process of trading back and forth with the other side until you discover the price that makes each of you least unhappy.  You may be bidding on something that the other person thinks is more valuable than yourself, or that you are offering something that you value more than other people out there who want to buy. When the final price is reached and both parties have agreed, the result is a contract, whether by handshake or by formal papers, that you will deliver your basket of currencies to the other party and that they will hand over their basket of currencies to you at a specific place and time. In practice, the actual exchange is usually a transfer from one current account to another in the two countries in which the currency is issued.