What is the Forex Market?
Forex Currency Exchange is the act of exchanging one country’s currency for that of another.
It is conducted by international banks, large financial institutions, large corporations and companies, and price action traders like us.
The Foreign Currency Market is also known as forex or “FX Market”.
The open market trades non-stop from Monday 8 am to Saturday 8 am, opening in New Zealand and Australia, and closing in the USA after Wall St Closes on Friday after New York time.
Forex is the largest and most liquid market in the world with an average daily turnover averaging $5,3 trillion a day according to the Bank for International Settlements.
No Central Exchange – Foreign exchange is an over the counter market, that means that there is no central exchange and clearinghouse where orders are matched. Geographic trading centers exist around the world however and are ( in order of importance) London, New York, Tokyo, Singapore, Frankfurt, Geneva, & Zurich, Paris and Hong Kong. Essentially foreign exchange deals are made between participants on the basis of trust and reputation to deliver on an agreement. In the case of banks trading with one another, they do so solely on that basis. In the retail market, customers demand a written legally accepted contract between themselves and their broker in exchange of deposit of funds on which basis the customer may trade.
The primary reason the Forex Market exists is to facilitate international trade and investment by giving business the ability to convert one currency into another. As an example, U.S Business can import goods from Japan and pay in Japanese Yen, even though the business is based in America and operates in U.S. dollars. The Forex market also provides a medium for speculation which works to add deeper liquidity to the market, making exchange rates less volatile.
The ‘Carry- Trade’ is facilitated via the Forex market, this is a trade in which investors can buy high-yielding currencies against low-yielding currencies and profit from the higher yielding rate.
Basic History of Forex
In 1876, something called the gold exchange standard was implemented. Basically, it is said that all paper currency had to be backed by solid gold, the idea here was to stabilize the world currencies by pegging them to the price of gold. It was a good idea in theory, but in reality, it created boom-bust part teens which ultimately led to the demise of the gold standard
The gold standard was dropped around the beginning of world war 2 as Major European countries did not have enough gold to support all the currency they were printing to pay for large military projects. Although the gold standard was ultimately dropped, the precious metals never lost its spot a the ultimate form of monetary value.
The world then decided to have fixed exchange rates that resulted in the U.S. dollar being the primary reserve currency and that it be the only currency backed by gold. This is known as the ‘Bretton Woods System’ and it happened in 1944.( Awesome hey). In 1971 the U.S. declared that it will no longer exchange gold for the US dollar that was held in the foreign reserves, this marked the end of the Bretton Woods System.
It was this break down of the Bretton Woods System that ultimately led to the mostly global acceptance of floating foreign exchange rates in 1976. This was effectively the ‘birth’ of the current foreign currency exchange market, although it did not become widely electronically traded until about the mid-1900s.
Who Trades Forex?
Central banks ( Governments), Commercial Banks, Large Financial Institutions, Insures.
Commercial companies/ Exporters and Importers ( Mining and Car Companies etc.)
Hedgers ( E.g Airliners, Farmers etc. Lock in the Currency Prices as well as hedge Products via offshore commodity futures.)
Commercial Traders ( Hedge Funds)
Retail Traders ( Us)
Travelers and Tourists
What is Forex Trading?
Forex Trading as it related to retail traders ( Me and You) is the speculation on the price of one currency against another. For example, if you think the Euro is going to rise against the U.S. Dollar, you can buy EURUSD currency pair low and then (hopefully) sell it at a higher price to make a profit. Of course, if you buy the Euro against the dollar( EURUSD), and U.S. dollar strengthens, you will then be in a losing position. So, it’s important to be aware of the risk involved in trading Forex, and not only the reward.
How are Forex Currency Rates Determined?
- Economic factors – These include economic policy made by government agencies and central banks and economic conditions as described by and through economic reports as well as various economic indicators.
- Political Conditions – International, national, and regional political conditions and events can have a large impact on the Forex currency markets.
- Market Psychology – The Psychology of market participants can influence the foreign exchange market in numerous ways. Ultimately all economic variables are expressed through the filter of the human brain/ trader psychology.
- Trading Algorithms – Electronic trading based on algorithms ( or computer price chart) is becoming more and more popular, as a result of algorithmic trading is starting to have a larger effect on the forex currency rates.
- All of these determining factors are reflected via the price action on a raw price chart. This is why price action is the best trading method; by learning to interpret and trade it, you are also taking account all variables that move a market, in the simplest and cleverest way possible.