What is Forex Trading
The changing values of the world’s currencies can be traded in much the same way as commodities such as corn, gold, or crude oil are traded. Foreign Exchange trading, or Forex, is utilized extensively for risk management by the world’s governments, financial institutions, and businesses, but like all other markets, speculators are needed to add volume and liquidity. The Foreign Exchange markets offer exciting opportunities to the speculator, not only because of their sheer size and high volatility, but also because they can be accessible even to traders with low capitalization. There is risk of loss in trading the Forex and it is not suitable for all investors.
What is Forex?
As we know because of exchange rates, every currency has a value that fluctuates. While the world traveler may see exchange rates quoted in familiar monetary values that appear to vary minimally over the course of a holiday trip, global currencies are constantly changing in value, and are usually quoted out to several decimal places! With literally trillions in dollars being traded on the Foreign Exchange every day, even the smallest increment of change can be significant! The minimum tick value of a currency will represent the monetary amount a trader may profit or lose on the movement of that currency’s value. There is a likelihood of loss when trading any markets including the Forex.
What are the 3 ways to trade Forex
There are three types of markets where currency traders of all kinds may manage risk or pursue speculative profit. While the term “Forex” has come to be used interchangeably with “Foreign Exchange,” the Forwards and Futures markets may sometimes be referred to with the term “FX.” The Spot market is commonly referred to as the “Forex market.”
Futures Market
Foreign currencies are traded as commodities on the futures market alongside well-known markets like crude oil, silver, pork bellies, and orange juice. The most commonly traded FX futures are the Euro, British Pound, Japanese Yen, and Swiss Franc. Other popular currencies include the Canadian and Australian Dollars. While financial institutions and companies around the world will use FX futures to manage exchange rate risk, speculators may pursue profit on the price movement of the various currencies, buying to trade for potential upward movement, and selling to seek profit to the downside. There is significant risk of loss in trading futures and options and it is not suitable for all investors.
FX futures are quoted in increments of the currency being traded: Euro futures are traded in Euros, British Pound futures are traded in British Pounds, etc. Trading is based purely on the changing value of each individual currency. Futures contracts on foreign currencies are offered on the CME Group, CME Globex, and ICE exchanges which are subject to regulatory oversight by the National Futures Association and the Commodity Futures Trading Commission.
Forwards Market
The exchange rates of the FX Forward market are primarily used to manage exchange rate risk on a future monetary transaction. A Forward rate is not today’s rate of exchange, but rather a rate for a pair of currencies to be exchanged in a future transaction within a specified expiration period. A Forward exchange rate factors in differences in interest rates between countries. Speculators can trade FX Forwards in an attempt to profit on interest rate differentials between currencies.
Spot Market
The “Spot Market” in foreign exchange is what most people associate with the term “Forex.” The Forex is the largest, most actively traded and most liquid financial market in the world with literally trillions being traded every day. Used by government, commercial, and speculative traders the world over, the Forex market is active, 24 hours a day from Sunday, 5:00pm EST (10:00pm GMT) when the business week begins in Southeast Asia, until Friday, 5:00pm EST (10:00pm GMT), when the western United States brings the week to a close. As a truly global market, the Forex crosses every border and therefore is completely electronic: There is no physical Forex exchange anywhere in the world!
If any one place can be called the center of the Forex market, that city would be London. Before the introduction of the Euro, the Forex was a critical element to conducting business across Europe with its many varied currencies. As the headquarters of European finance, London remains the most actively followed trading session for foreign currency traders who then transition into the New York session when London action starts to slow down. Just as New York traders are ready to call it a day, business is waking up in Sydney, Australia, which will flow into the Tokyo trading session within a few hours. Forex traders can follow the trading session of a global financial center around the clock!
Unlike FX futures which trade individual currencies, Forex trades currencies in pairs with the exchange rate quoted as the value of one currency rises or falls against the other. The most actively traded pairs are known as the Majors:
EUR/USD: Euro against the US Dollar
GPB/USD: British Pound against the US Dollar
USD/CHF: US Dollar against the Swiss Franc
USD/JPY: US Dollar against the Japanese Yen
Literally a “world” of other currency pairs can be traded, from the popular Australian Dollar/US Dollar pair (AUS/USD) to exotics such as the US Dollar against the Singapore Dollar (USD/SGD) or even the US Dollar against the Polish Zloty (USD/PLN).
Currencies that are not paired against the US Dollar are called Crosses and include these popular combinations:
EUR/CHF: Euro against the Swiss franc
EUR/GBP: Euro against the British pound
GBP/CHF: British pound against the Swiss franc
GBP/JPY: British pound against the Japanese yen
AUD/JPY: Australian dollar against the Japanese yen
AUD/NZD: Aussie dollar against the New Zealand dollar
CHF/JPY: Swiss franc against the Japanese yen
With world economic news readily available in all forms of the media and a dynamic, highly liquid and volatile global market, the Forex offers exciting opportunities to the speculative trader! There is risk of loss in trading on the Forex market.
