Jun 11, 2020
The forex market (also known as the FX market) is a global decentralized market for trading currencies, which includes buying, selling, and exchanging them at preset or current prices. It is by far the largest market in the world in terms of trading volume and determines the foreign exchange rates for every currency.
Forex, or foreign currency exchange, trading can be broken down into several key components:
- The market
- The broker
- The trading software
- The trader
The Forex Market
The FX market is the most traded market in the world; $1.5 trillion are traded on it on a daily basis. The main participants of the forex markets are large international banks like JP Morgan, Deutsche Bank, Citi, BS, Goldman Sachs, etc. Currencies are always traded in pairs on a 24/5 basis (the market does not work on weekends or public holidays) and the main pillars of trading between buyers and sellers are financial centers: London, New York, Tokyo, Zurich, Frankfurt, Hong Kong, Singapore, Paris, and Sydney. Financial centers offer direct access to large capital pools from banks, capital markets, investment funds, and insurance companies. They are also major global cities.
The FX market operates on several levels: there are the so-called dealers who are usually banks who trade large quantities of foreign currency. It operates on a 24-hour basis due to various international time zones and because it is conducted online versus over a physical exchange. Securities (domestic stocks, bonds, and commodities), on the other hand, are not relevant on an international stage therefore they only trade throughout the standard business day.
Forex trading starts in Australia and Asia, then is followed by Europe and North America. Trading is continuous because when one market closes another opens. Often markets will overlap for several hours which is usually when trading is most active.
The Forex Broker
Forex brokers are companies that offer traders access to exchange currencies through their platforms. They offer their services to retail traders mainly, which means that forex brokers themselves actually handle a very small portion of the overall volume of the FX market. Retail currency traders will use these brokers to access the market and speculate currencies. Forex brokers earn money essentially on the bid-ask spread.
Forex brokers provide access to all major currency pairs, just the EUR/USD, GBP/USD, USD/CHF, and USD/JPY amongst others. More brokers will also offer minor and exotic currency pairs that are from emerging markets.
Forex brokers allow traders to purchase a currency pair and then close the trade, by selling the same pair. For example, if a trader wants to exchange GBP for USD, they will buy the GBP/USD pair. This will equal buying GBP and using USD for the purchase and when the trader closes the trade, the pair will be sold. If the exchange rates were higher when the trader closed the trade then they have a profit, otherwise, the traders would realize a loss. Forex brokers are compensated on the bid-spread amount, which means that when the retail client opens a position at the asking price, and then eventually closes it on the bid price, the forex broker will receive the spread amount which is the difference between those two.
The Trading Software
There are numerous software programs available, both web-based, and desktop-based, for trading forex. Most brokers will offer their clients a software package for free or as part of their trading account. Normally, the software that comes with a trading account is just a very basic version with more features available for an additional price. Traders select the best suitable trading forex for themselves based on their trading style. A good tip for new traders would be to download different software types and try some various packages using a demo account, to understand which software is most suitable for their style of trading.
Forex trading software is available either on desktop or web-based software. Which option every individual trader chooses very much depends on their personal preference as well as technical factors; for example, web-based software tends to be more secure than desktop-based software. This is because desktop-based software stores data, on the computer’s hard drive and is subject to security issues.
Due to the extremely dynamic nature of the forex market, traders must have reliable, fast, and up-to-date internet connection.
There are different types of traders out there, but most of them share some common characteristics: intelligence, intuition, and most importantly, courage. But one key component is timing. Various timeframes assist brokers to define their strategies and develop their techniques. This may come in the form of leveraging different currency pairs, taking advantage of scheduled or unscheduled market news releases, etc. The most common ways that traders are identified are:
- Day Trader: Day traders are market participants that trade high-volumes and do not hold positions after the session closes. Typically, they will have quick turnover rates on their trades and try to capture more profits from a smaller trade.
- Swing Trader: Swing traders will normally hold positions for several hours and take advantage of the longer timeframes.
- Position Trader: Position traders will usually hold a position for the longest time out of all three since they follow a different perspective. They do not monitor short-term market moves but instead, look at the market on a more long-term basis.
A Brief History of Forex Trading
Forex trading goes far into ancient times where money-changers would help people change money for a commission. Exchanging currencies first emerged in the 4th century AD and was witnessed across ancient regions all over the world. Precious metals such as gold and silver became the tool for exchange which soon lead to the creation of coins. The forex market that we know today was born in the 1930s when the gold standard was removed.
Modern forex trading started in the early 1970s with its major transformation happening towards the end of World War II. The Bretton Woods Accord was formed to create a stable environment where global economies could reestablish themselves and with this attempt, the foreign exchange market that we know today came to exist.
In the early 90s, the USD appreciated greatly against other major currencies which made it difficult for exporters. The weight of the USD affected third-world nations greatly and lead to the establishment of the ‘Plaza Accord’, which was a joint agreement between France, West Germany, Japan, the U.S, and the U.K to depreciate the U.S dollar in relation to the Japanese yen and German Deutsche Mark by dominating currency markets.
Following this intervention, traders started realizing the potential profit that’s available through currency trading, specifically during fluctuations. After the Euro was introduced in 1992, the currency market became more and more sophisticated. Internet trading became widely accessible and this opened doors to currencies from totalitarian systems that could now be traded globally, offering Southeast Asian economies to grow and flourish.
The Modern Forex Market
Currently, the foreign exchange market is the most liquid financial market in the world, with a wide range of participants such as governments, central banks, commercial banks, financial institutions, speculators, commercial organizations, and of course, retail traders that are individuals.
Forwards and futures are another way to participate in the forex market. Both include the agreement to purchase and sell assets at a future date and have prices derived from a certain underlying asset, however, forwards follow the over-the-counter (OTC) process, where two counterparties negotiate and arrive on the exact terms of the contract, for example, its expiration date. Futures are more readily available to speculators and individual traders. Currencies are traded in lots: micro, mini and standard lots with a micro lot worth 1000 units of a certain currency, while a mini lot is worth 10,000 and a standard lot is worth up to 100,000.
The forex market is highly attractive to traders and investors because it is not as heavily regulated as other markets such as the stock, futures, or options markets. No central body governs the entire forex market, and anything can be short-sold at any given time because you are not actually shorting, since if you sell one currency you buy it for another. For brokers, the FX market is highly advantageous mainly because there is little to no regulation over how they charge their fees or commissions. Furthermore, due to no cut-off times, forex brokers can generate money at any hour of the day with the exception of weekends and public holidays of course.
Stay tuned for part 2 of our FX trading guide…