The Forex Market
Because of its increasing popularity over the past several years, most people have at least heard of Forex trading at this point. Many, however, still don’t really know what the Forex, or foreign exchange, market is and how it works. Here’s everything you need to know to understand the basics of the Forex market and begin learning about how to trade within it.
What is the Foreign Exchange Market?
In essence, the foreign exchange market is the totality of all currency markets in the world. Every unit of currency in the entire global economy is, in a sense, one tiny data point of the overall Forex market. The relationship between these currencies, however, is where the trading market is truly generated. The value of any currency is always expressed in relation to another currency, meaning that the entire Forex market is in a state of constant and very dynamic flux.
When the value of one currency changes relative to another, an investor has the opportunity to make money. As a very simple example, suppose you were a British investor who bought £100 worth of American dollars. If the value of the dollar relative to the pound increased, you would be able to convert that money back into more pounds than you originally invested. If you can accurately predict the movements of relative currency values in the Forex market, you can use them to make money. At its core, this is what Forex trading is.
How Are Forex Values Expressed?
In order to trade currencies effectively, the Forex trading industry has constructed what are known as Forex currency pairs. These are pairings of common global currencies whose values are measured against each other. Although any two currencies can, in theory, be traded as a Forex currency pair, most Forex brokerages deal primarily in a group of high-volume pairs known as the “majors.” Following is a list of the major Forex currency pairs most traders deal in:
- GBP/USD
- EUR/USD
- USD/JPY
- USD/CAD
- USD/CHF
- NZD/USD
- AUD/USD
Most Forex trading will deal with these pairs. However, aspiring Forex traders should also learn the ins and outs of trading the so-called “minors,” or less frequently traded pairs, as these can also offer good opportunities for profit. The AUD/JPY pair, for example, is a favorite of high-level traders because of the high volatility that is characteristic of both of its included currencies.
What Affects the Forex Market?
Modern currencies and their values are reliant on a huge number of individual economic factors. In reality, almost everything that happens in a nation’s economy impacts the value of its currency. Some of the most important and predictable events that come into play in Forex trading are the quarterly economic statistics that most countries release throughout the year. Predictable seasonal market changes, such as the increase in retail sales around Christmas, can also have an effect on the value of a currency.
Many of the largest changes in currency values are caused by economic events that are less predictable. National stock markets, for example, have a profound impact on the strength of a country’s currency. When stock markets crash or enter a declining period, currencies can lose a substantial amount of value. Similarly, a general shift in commodity prices can cause currency values to fluctuate. These effects will vary substantially based on the economy of the individual country in question, so a good working knowledge of the markets of various major nations is invaluable for a Forex trader.
In some cases, political shifts can also affect the overall value of a currency over time. When Britain voted to leave the European Union, for example, the British pound lost a portion of its value because of the predicted short-term effects on the British economy. This same shift can also happen less directly as a result of changes in consumer confidence following a given political event.
Who Trades the Forex Market?
Before the advent of online trading, Forex trading was still an extant investment method. In earlier times, however, it involved making large individual purchases of hard currency and later selling it at a profit, making the system far less efficient. Banks, at that time, were the primary trading force in the Forex market, as they were among the only institutions with enough capital to trade currencies effectively.
Today, banks are still by far the most powerful trading force in the Forex market. Large investment banks typically have substantial Forex assets, often under dedicated management. Some financial managers have also been able to break into the Forex market and create retail-level managed Forex accounts. The greatest change in the use of the Forex market for trading purposes, however, has been the emergence of large numbers of individual Forex traders.
How Do You Access the Forex Market?
While in the past currency exchanges served as the basic access point into the Forex market, the internet today is filled with specialized Forex trading brokerage platforms. These platforms use simple trading interfaces to organize the buying and selling of currencies, making it relatively easy for almost any investor with an internet connection to enter the Forex trading market. Some stock brokerages also give their investors the ability to invest in Forex currency pairs, but the specialized brokerages tend to have somewhat lower trading costs and be better-equipped for advanced Forex trading.
Conclusion
Though the Forex market is both vast and multi-faceted, its basic principles are fairly easy to understand. It consists of all of the national currencies in the world and is driven by their relations to one another. By buying and selling these currencies as they fluctuate, traders are able to make money. Though this market was once dominated by larger financial institutions, it has more recently become democratized enough for small, individual traders to get into it. If you’ve been looking for an income-producing investment option, consider giving Forex trading a try.