What Is Forex Trading?

What Is Forex Trading?
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You’ve probably heard how forex trading can be very beneficial. However, chances are, each time we hear the phrase forex trading, most of us are just going to ignore it because we think that it is some weird, complicated term that is too confusing for us to understand. For people who are not updated in the field of economics and business, the term can indeed be such an alien.

Many people will think that forex trading is a difficult subject, and although it can be true, it is definitely not an impossible subject to study. Many of currently successful forex traders started from zero, too. They used to be common people with little to no knowledge of economics and especially the subject of forex trading. However, those people continually educate themselves on the subject while practicing what they study. With a lot of determination, it is not possible to be gradually turned into a very good trader that brings home a lot of profit from forex trading.

Everyone can trade, but first, we need to understand the basic of what the business of forex trading is about. As we dig deeper and know better, we will have a more thorough picture of what to do to be a forex trader.

Forex trading

Forex marketForex trading, or foreign exchange trading, is a unique kind of trading. Unlike other forms of trading that we commonly see or practice, the traders don’t exchange goods or service. In the world of forex trading, people trade currency. Therefore, forex trading is the trade between currencies of different countries. To make it simple, imagine an activity at financial institutions where people buy a certain currency, such as the American dollars (US$) by selling their Australian dollars (AUD). Forex trading is not that simple, but it’s a start.

Forex is offered in the form of currency pairs. Unlike the stock market where we can buy or sell individual stocks, we have to buy a currency and sell another in the forex market. Because of this, we must have a lot of knowledge in not only a single currency but multiple.

The forex market

Besides the materials traded, the trading location is also what makes forex trading different from the traditional kinds of trading. We usually buy and sell some goods in a market with a physical location and actual building. We see what we want to buy then choose and pay. A forex market is also a place where sellers and buyers meet to do their transactions. However, there is no physical location of this market. Buyers and sellers don’t actually meet face to face to conduct their businesses.

In the forex trading world, the market is operated online. The Internet is the home and the media to connect buyers and traders. Because of this flexibility, the forex trading transactions are done massively and instantaneously. People from around the world are connected and involved. Moreover, because it is internet-based, it operates every second during the 24 hours of a day. There is no day off. This definitely makes it easier for forex traders to do their transactions from anywhere they are. We can even have a full-time day job and still trade smoothly because of the no boundaries offered by the nature of forex trading.

Therefore, the traders also come from every place. A trader is not necessarily an individual. It can even be representing a bank, a major company, an institution, and even a country.

When did forex start?

As the world continued to tear itself apart in the Second World War, there was an urgent need for financial stability. International negotiators from 29 countries met in Bretton Woods and agreed to a new economic system where, amongst other things, exchange rates would be fixed.

The International Monetary Fund (IMF) was established under the Bretton Woods agreement, and started to operate in 1949. All exchange rates changes above 1% had to be approved by the IMF, which had the effect of freezing these rates.

By the late 1960’s the fixed exchange rate system started to break down, due to a number of international political and economic factors. Finally, in 1971, President Nixon stopped the US dollar being converted directly to gold, as part of a set of measures designed to stem the collapse of the US economy. This was known as the Nixon shock, and lead to floating rate currency markets being established in early 1973. By 1976, all major currencies had floating exchange rates.

With floating rates, currencies could be traded freely, and the price changed based on market forces. The modern forex market was born.

Statistics

According to the last triennial survey of the Bank of International Settlement (BIS), the size of the forex market turnover as at 2016 was $5.2 trillion. This makes the forex market the biggest financial market in the world. Over $4 trillion dollars worth of currency are traded each day. The amount of money traded in a week is bigger than the entire annual GDP of the United States! The main currency used for forex trading is the US dollar.

Below is a list of the 5 most traded currencies
  1. Unites States Dollar – USD ($) – 87.60%
  2. Euro – EUR (€) – 31.4%
  3. Japanese Yen – JPY (¥) – 21.6%
  4. British Pound Sterling – GBP (£) – 12.8%
  5. Australian Dollar – AUD ($) – 6.9%

Five major currencies chart

What is the purpose?

Just like the purpose of conventional trading, people are involved in forex trading are driven by the search for profit. The aim is to obtain as many profits as possible. Every economic activity is just like this. It is done to maximize profits.

Who trades on the forex market?

There are many different players in the forex market. Some trade to make profits, others trade to hedge their risks and others simply need foreign currency to pay for goods and services. The participants include the following:

  • Government central banks
  • Commercial banks
  • Investment banks
  • Brokers and dealers
  • Pension funds
  • Insurance companies
  • International corporations
  • Individuals

When is the forex market open?

Unlike stock exchanges, which have limited opening hours, the forex market is open 24 hours a day, five days a week. Banks need to buy and sell currency around the clock, and the forex market has to be open for them to do this.

What factors influence currency exchange rates?

As with any market, the forex market is driven by supply and demand:

  • If buyers exceed sellers, prices go up
  • If sellers outnumber buyers, prices go down

The following factors can influence exchange rates:

  • National economic performance
  • Central bank policy
  • Interest rates
  • Trade balances – imports and exports
  • Political factors – such as elections and policy changes
  • Market sentiment – expectations and rumours
  • Unforeseen events – terrorism and natural disasters

Despite all these factors, the global forex market is more stable than stock markets; exchange rates change slowly and by small amounts.

So how do we obtain this?

profitable trading

To make the activity of forex trading profitable, every trader should be able to foresee what is coming. Of course, it has nothing to do with paranormal activities involving crystal balls or visions. On the contrary, the foresight is analytical and cold. Every trader needs to be able to predict how the price of certain currencies will rise and fall in the coming future. To have this skill, a trader must learn a lot of things.

The price of the currencies in the forex market fluctuates all the time. The fluctuation can be great and sudden. The change of a currency’s price is influenced by a lot of factors happening inside and outside the country, for example, economic condition, interest rate, natural disaster, or security problems. Political events and geopolitical conflicts can also influence this fluctuation significantly. However, the basic drive in this fluctuation is supply and demand mechanism. When the world needs more USD, then the value of the currency will increase. As a result, the price will rise, too. Conversely, when the world has too many USDs, the abundance of the currency will make the price drop. The force behind the stock market can also influence the value of the currency.

Because of the fluctuating nature, if we want to be a good trader who gets as many profits as possible, we must be able to predict how the current situation will influence the price of a currency. We must be knowledgeable, open our eyes and ears, analyze and make brave predictions.

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Why we should learn forex trading

Some of you might question why I advocate forex trading. What are actually the benefits of forex trading compared to other financial products?

As I have explained before, the forex market has a lot of potentials. It is also continually developing from time to time. We can also learn to trade without having to worry that our daily activities may be disturbed. Students, employees, and even stay at home parents can do this in the middle of their daily activities. People from around the world don’t have to wait until they find buyers to start selling, and neither do the buyers.

There are also potentials to gain a lot of profits if we are okay to play high-risk games. With the right knowledge and practice, this can be a way to good fortune and all big dreams we’ve ever dreamed of.

The forex market has many advantages. These include the following:

  • It’s already the world’s largest market and it’s still growing quickly
  • It makes extensive use of information technology – making it available to everyone
  • Traders can profit from both strong and weak economies
  • Trader can place very short-term orders – which are prohibited in some other markets
  • The market is not regulated
  • Brokerage commissions are very low or non-existent
  • The market is open 24 hours a day during weekdays
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