FX or Forex describes the Foreign Exchange Market, a marketplace where the world's various currencies are traded. It is an interbank market which was created in 1971 when international trade transitioned from fixed to floating exchange rates. Its huge volume and fluidity made the Forex market the largest and most significant financial market in the world, with well over $4 trillion traded daily. By way of comparison, the Forex market is 100 times larger than the New York Stock Exchange, and triple the size of the US Equity and Treasury markets combined. Forex is an over-the-counter market (no central trading arena), meaning that transactions are conducted via telephone or internet by a global, decentralized network of banks, multinational corporations, importers and exporters, brokers and currency traders.
Here are some unique characteristics that are the source of its success:
- Forex markets operate 24 hours a day.
- Liquidity: The daily turnover of the FX market – over 4 Trillion Dollars – makes it easy to trade most currencies with immediate execution.
- Traders can capitalize from rising or falling markets.
- The benefit of leveraged trading with low margin requirements.
- Traders can control the risk with instruments such as stop loss or take profit orders
- Transparency: The Forex market is 100% transparent - you just need make sure you are well informed.
The main participants in the Forex market are: central banks, commercial banks, financial institutions, hedge funds, commercial companies and individual investors. The main reasons they participate in the Forex market are:
- Speculation - Profit from fluctuations in currency pairs
- Hedging - Protection from fluctuating currency pairs which is derived from trading goods and services
With technological development, the World Wide Web has become a great trading facilitator, as it can provide individual investors and traders with access to all the latest Forex news, technology and tools.
Trading on the Forex Market: Basic Concepts
Forex is the buying of one currency and the selling of another concurrently. Typically, the major currencies—the British Pound (GBP), the Euro (EUR), the Japanese Yen (JPY), and the Swiss Franc (CHF)—are traded against the US Dollar (USD). Trade pairs in which the USD is not included are called cross pairs, and occur much less frequently.
The currency pairs are expressed with a base currency as the first part of the pair, followed by the quote currency. (For example, USD/JPY would be the US dollar as the base against the Japanese Yen as the quote.)
Accompanying the currency pair is the quota, or bid/ask price. This is expressed in the following format: EUR/USD : 1.2836 1.2839. The first number in the series represents the bid price, the cost of selling the Euro against the Dollar, or going ‘short' on the Euro. The second number is the ask price, the cost of buying the Euro against the dollar, or going ‘long’ on the Euro. The difference between the bid/ask price is called the pip spread.
A pip is the smallest unit of measure for any currency. In most currencies, this is the fifth digit, or the fourth after the decimal point; in dollars, each pip is equivalent to one-hundredth of a penny. One important exception is the Japanese Yen, in which each pip is the second unit after the decimal point, meaning each pip equals one cent.