The term Forex refers to ‘foreign exchange’ which is a decentralized global market where all the world’s currencies are traded. Forex trading is hence in simple words, the act of trading the different world currencies, against each other.
Whether we realize it or not, we currently live in an era where the currencies of the world are perhaps as important as our own. If we are on a trip to France we cannot pay in rupees to purchase croissants, we need euros. To go on a trip to Disney land in the US, we need to pay in dollars. In situations as such, we most definitely need to exchange our home currency for the foreign local currency. To do this, we usually visit one of those stores advertising signs stating ‘Foreign currency sold/ exchanged here’. In order to be able to provide us with such currency, these brokers themselves need to purchase this foreign currency, which is done in the foreign exchange market.
The foreign exchange market is the biggest, most liquid financial market in existence, and dwarfs all others including the stock market with an estimated trade value of around 2000 billion a day.
One of the important facts about the foreign exchange market is that there is no established brick and mortar market space for forex trading. The Forex market remains open around the clock and currency trading is conducted at every hour, electronically over the counter, which means these transactions occur via a computerised network between the traders and the world rather than on a centralised exchange.
In the Forex market, all trade involves two currencies or rather, a pair of currencies, because you bet the value of one against the other. If for example, we trade Euros for Dollars, there are thus two currencies involved. Here the Euro is the base price and the dollar, the counter against which it is measured. When we venture forth to trade these currencies in the forex market, two prices are quoted to us. One is the buying price and the other, the selling price. The difference between the two is called a ‘spread’. After thus comparing the price of one currency in relation to the other the course of trade is decided such that, if you feel the euro will increase in value against the dollar, you will buy EURO/USD and if you think the euro will drop in value, you will sell the EURO/USD. If the trade further, moves in your favour and you cover the spread, you make a profit. If not, you are left in a loss. Today The US dollar is the most traded currency in existence.
There are generally three ways of forex trading: Through the spot market, the forwards market and the futures market.
1- The Spot Market:
The spot market is where the currencies are traded according to the current price. This price is a reflection of factors including current interest rates, economic performances and the perception of the future performance of one currency against the other. When a deal is finalized it is called a ‘pot deal’ and one party delivers the agreed-upon currency amount to the counterparty and receives the specified amount of another currency at the agreed-upon exchange rate. The settlement takes around two days and is done in cash.
2- The Forwards Market:
Unlike spot markets, the forwards and futures markets don’t trade in actual currencies. Instead, they deal in contracts that include claims to a certain currency type, a specific price per unit and a future date of settlement.
In a forwards market, there is trading of contracts OTC between parties and the terms of the agreement are decided by them beforehand.
3: The Future’s Market:
The contracts traded in a future’s market are based on a standard size and settlement date. The futures contracts have specific details listed out such as the settlement and delivery dates, number of units, minimum price increments and more.
Today, thanks to globalisation and an increased requirement for foreign currencies, the forex market still remains the biggest market in the world with a trading volume that all the combined stock markets cannot come close to. And because of features including Volatility, Accessibility and a large number of possibilities attached to it, the market is sure to remain the same way for the decades to come.