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What Is Forex Trading?

By Louis Holding-Parsons on May 27, 2018

5 (100%) 2 votes

The foreign exchange market is where currencies are traded. The Currency market exists because currencies need to be exchanged in order to conduct business as a result the forex market is the largest, most liquid financial market in the world. Knowing what is Forex is not only about learning the terms but appreciating the impact of it:  It is larger than the stock market, with CLS, a major settler of trades in the FX market, stating the average daily traded volume submitted to it had risen to $1.805 trillion in January 2018.

There are many terms used to describe what is Forex such FX, foreign-exchange market and currency market.

What is Forex and How Does it Work?

What is Forex

Currency markets are only closed from Friday evening to Sunday evening, but are open the rest of time and are split into three sessions that include the European, Asian and United States trading sessions. Although there is some overlap in these sessions, the main currencies in each market are traded mostly during those market hours. Certain currency pairs will have more volume during certain sessions. Traders who stay with pairs based on the dollar will find the most volume in the U.S. trading session.

There is no central marketplace for foreign exchange. Currency trading is conducted electronically which means that all transactions occur via computer networks between traders around the world, rather than on one centralized exchange. Currencies are traded worldwide in the major financial centers of:

  • London
  • New York
  • Tokyo
  • Zurich
  • Frankfurt
  • Hong Kong
  • Singapore
  • Paris
  • Sydney

This means that when the trading day in the U.S. ends, the forex market begins in Tokyo and Hong Kong. As such, when asking what is forex market, one should realise that it can be extremely active any time of the day, with price quotes changing constantly.

Fewer Products

What is Forex
The majority of the volume in currency trading is confined to only 18 currency pairs with eight currencies most often traded – these are

 

 

  • The U.S. dollar (USD)
  • Canadian dollar (CAD)
  • Euro (EUR)
  • British pound (GBP)
  • Swiss franc (CHF)
  • New Zealand dollar (NZD)
  • Australian dollar (AUD)
  • Japanese yen (JPY)

When learning what is Forex, you will quickly appreciate that currency trading can be easier, as having far less trading options makes trade and portfolio management an easier task.

Spot Market and the Forwards and Futures Markets

There are three manners that institutions, corporations and individuals trade forex: the spot market, the forwards market and the futures market. The forex trading in the spot market has always been the largest market because it is the “underlying” real asset that the forwards and futures markets are priced on. When people refer to the forex market, they usually are referring to the spot market. The spot market is where currencies are bought and sold according to the current price which is influenced by a variety of factors such as supply & demand, interest rates, economic performance and politics.

The forwards and futures markets tend to be used by companies that need to hedge their foreign exchange so as to mitigate a currency moving against them – think a UK based airline buying oil in dollars but paying in Sterling. Learning what is Forex is also appreciating that the market is underpinned by a fundamental business requirement. Forwards and futures markets do not actually trade currencies but instead contracts which gives rights to a certain currency type, a specific price per unit and a future date for settlement.

Speculators are a large part of these markets too and will look to make money from future exchange rate fluctuations.

Getting to Know Interest Rates

What is ForexUnderstanding interest rates is important in learning what is forex trading and requires a good awareness of the underlying economics of the country in question. Usually countries with strong growth rates and increasing inflation will probably raise interest rates to tame inflation and control growth. Countries that are in a recession will usually reduce interest rates to encourage growth. If one currency has a higher interest rate, that currency can become more attractive to speculators, which makes that currency more attractive and more in demand, leading it to rise.

Carry trade

Currency values never remain stationary, and anyone wanting to learn what is forex will need to know one of the most popular trading strategies of all time, the carry trade. Carry traders hope to earn a better interest rate by selling a currency which has a low interest rate (i.e. cheap to borrow) and buying a currency which a high interest rate, with the profit being the extra interest earnt through the currency paying a higher rate. Not necessarily for the faint-hearted,

This is a trading strategy which has been compared to picking up pennies in front of a steamroller!

Picking pennies off the floor may be easy but when the steamroller catches up to you, you may want to be somewhere else! Currencies rarely stay stable for long, so although you may pick up extra interest you may find the FX rate has moved against you whilst you are engaging in a carry trade. When learning what is Forex you should be aware of the pitfalls of high risk trades!

FOREX as a warning

What is ForexCentral Banks are very active in Forex markets due to their mandates to ensure their countries currency remains stable which they can undertake through actively buying or selling their currency depending on what they are trying to achieve. Indeed the NY Fed and Band of England websites are interesting for anyone wanting more details of what is Forex. Sometimes a central bank can become undone when it tries to defend its currency against speculators, George Soros came to be known as

‘The Man Who Broke the Bank of England’

after he took on the Bank of England on a historic trade and shrewdly wagered on a devaluation of the British pound. But there is another reason central banks are active in Forex markets: warning signs. When a stress appears in any asset class, the Forex market will often be the first asset class to display the contagion as market participants flee to US dollars which is seen as the currency of safety.

Conclusion

Learning what is Forex should be the first step before considering opening either a demo or live account – where it’s recommended to start with small sized trades: no more than 1% of your capital!

Knowing what is Forex means understanding the terms and expressions used. Taking this information and learning how to trade is the next step. This will mean learning specific concepts and learning to control your emotions – easier said than done! Making mistakes when you start is normal, but ensuring these are small mistakes will help you protect your capital and live for another (more successful!) day!

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Louis Holding-Parsons

Louis is a portfolio manager and a trader who brings a wealth of experience in private banking to The Lazy Trader. A fundamentalist and a trouble-shooter, Louis makes a firm contribution to the trading team.

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Louis Holding-Parsons

Louis is a portfolio manager and a trader who brings a wealth of experience in private banking to The Lazy Trader. A fundamentalist and a trouble-shooter, Louis makes a firm contribution to the trading team.

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