The term Forex is the contraction of the English term Foreign Exchange. It refers to the market on which currency is exchanged. There is no central market place to exchange currencies; Forex is therefore an over-the-counter market that is active in major international financial centres (London, New York, Tokyo, Zurich, Frankfurt, Hong Kong, Singapore, Paris, Sydney).
Forex is the largest financial market in the world with a daily trading volume estimated at nearly $5.3 trillion. This is the largest and most liquid market in the world in terms of transaction volume.
Unlike the stock market, Forex allows orders to be made 24 hours a day and five days a week (banks are closed on weekends). Forex has long been reserved only for wealthy people, but in recent years a simple individual can get started with a bet of only a few tens of euros, thanks to the appearance of many online forex brokers.
How Forex Trading Works
Forex trading is fully dematerialized and decentralized and is not attached to a particular stock exchange. It therefore allows transactions on currencies almost 24 hours a day every day of the week. Almost all transactions are carried out over the counter: brokers and banks trade directly with each other, without a stock exchange intermediary. Forex is therefore an unregulated market.
The main players in Forex trading are banks and brokers that allow individuals to trade online. They provide financial instruments to hedge or speculate on changes in currency prices. With online trading sites, it is possible to access the market via an exchange platform and real-time quotes. The broker’s remuneration is usually done on the spread which corresponds to the difference between the purchase price, called the bid price and the selling price, the ask price. Most brokers offer attractive forex bonuses to encourage trading, such as doubled deposit sums or other bonuses.
On forex, currencies are always sold and bought two to two, so we are talking about pairs. For example, you can exchange euros for U.S. dollars. An easy way to do this is to position yourself on EUR/USD pair. When the EUR/USD pair has a rating of 1.3105, it can be:
- or buy 1 euro against 1.3105 dollars (they say you buy the pair)
- or sell 1 euro against 1.3105 dollars (they say you sell the pair)
The fourth decimal place of the rating is called the pip. Thus, when the listing goes from 1.3105 to 1.3107, it is said that it has gained two pips. Conversely, when the rating goes from 1.3105 to 1.3103, it is said that it has lost two pips. Indeed, the exchange price of the currency pair is unstable and constantly changing. This makes profit in two ways:
- either by buying the pair and then reselling it some time later when its listing has risen;
- either sell the pair and then buy it back a while later when its listing has dropped.
In order to make a profit, it is therefore necessary to know how to correctly anticipate the direction of evolution of the quotes.
It should be noted that the EUR/USD pair differs from the USD/EUR pair and is subject to two separate quotes, but are closely linked. So if you have euros to exchange for U.S. dollars, you can:
or sell euros by getting paid in dollars. The EUR/USD pair is then sold, as seen above. If the EUR/USD parity is worth 1.3105, then one sells 1 euro against 1.3105 dollars;
or buy dollars by paying in euros. We then buy the USD/EUR pair. For a parity of 0.7632, one buys 1 dollar against payment of 0.7632 euros.
The U.S. dollar (USD) remains the benchmark currency in the currency market. In practice, a currency is always quoted against another currency that serves as a repository. The dollar can thus be quoted according to the euro, the Australian dollar, The Canadian dollar, the pound sterling…
One of the essential characteristics of Forex trading is leverage: Forex brokers allow their clients to bet more money than they actually have on their account, so we talk about leverage.
Thus, leverage allows to put on the market a sum up to a thousand times more than that which the customer possesses but with a high risk taking. There are several levels of leverage ranging most often from 1:100 (investment on a currency pair is multiplied by 100) to 1:400.
It is common to use leverage for Forex trading, as changes in currency pair prices are often very small and it would be very difficult to make profits without this effect.
If your broker authorizes you a leverage of 100 euros, it means that for 100 euros deposited in your account, you can invest 100-100 – 10,000 euros.
This technique allows you to multiply your winnings in an extraordinary way if you have found the right trend. But it can also speed up your losses if you don’t, and can even lead you to lose more than your starting bet. This technique should therefore be reserved for the most discerning investors.