What Is Forex and Why Should You Trade It?

Forex or FX stands for ‘Foreign Exchange Market’ and it is the largest financial market in the world. It is a global market that allows the exchange of one currency to another!

When travelling abroad, you’re essentially using the FOREX Market; you are selling one currency for the chosen alternative. For example, if I wanted to travel to the USA from the UK, I would need to buy United States Dollars (USD) and sell my Great British Pounds (GBP) – just like you would do so on the FOREX Market.

When trading on the Foreign Exchange Market, you are trading a CFD (Contract For Difference). This is essentially a contract between an investor and a broker/bank. At the end of the contract, the two parties exchange the difference between the opening and closing prices of a specified financial instrument, including shares or commodities and currencies.

When you are exchanging your currency to go abroad, YOU own the exchanged currency. When you are trading a CFD, you do not OWN the exchanged or traded currency; you are simply trading the contract.

To understand the size of the Forex Market - The New York Stock Exchange trades around $22.4 billion a day, whereas the Forex Market trades $5 trillion a day, therefore proving there is huge volatility and liquidity in the Forex market which creates great opportunity.

What Is Traded In Forex? It is basically… MONEY!

Think of Forex as buying a share in a particular country, like buying a stock in a company.

If you’re buying Dollars, you’re buying a share in the US Economy. You are in effect making a bet that the US Economy is doing well, and hopefully will continue to do well, so therefore you will return a profit in the future. Vice versa, if you are selling the dollar, you are betting against the US Economy.

The Exchange Rate of one currency versus another currency is a reflection of that country’s economy, in comparison to other countries economies. Consequently, the stronger the economy [of a country], the stronger the currency.

What Do The Abbreviations Mean?

All currencies have 3 letters to aid us in distinguishing one from another. The way in which this is done is simple: The name of a country, paired with the name of their currency! The first two letters of the abbreviation identifies the name of the country and the last letter identifies the name of the currency.

What Moves the Market?

Supply and demand of a currency is the main driver of the Forex Exchange movement. If the demand for a currency - for example, the US Dollar - increases, so will the rise in people looking to convert their currency into Dollars. This will lead to its price to go up, unless supply also rises to match the increased demand.

This is the same with supply: If the supply of a currency goes up without a parallel rise in demand, then its currency will drop in value.

Central banks also have a massive role to play in currency movement – they can control the supply and demand of a currency by controlling economic factors such as Base Interest Rate.

Without going into too much economic detail - interest rates increase/decrease the foreign direct investment into a country. Typically, higher rates reduce investment, because higher rates increase the cost of borrowing. It also requires investment to have a higher rate of return to prove profitable and vice versa. Investment creates a demand for a currency causing the currency to rise in value.

Who Trades Forex and When Can It Be Traded?

The big players in the Forex Markets:

  • The Government (Central Banks) - such as the European Central Bank, the Bank of England, and the Federal Reserve

    These are regularly involved in the Forex Market! Just like companies, national governments participate in the Forex Market for their operations, international trade payments, and handling their foreign exchange reserves.
  • The Super Big Banks

    Examples include: JP Morgan, Citibank, UBS, Deutsche Bank.

    These guys have huge amounts of capital and due to the banks large presence in the Forex Market, they have the ability to drive short term market trends.
  • Large Companies and Business

    In the 21st century companies are now more global than ever. Samsung, for example, might produce its phones batteries in China, screens in Vietnam and Logic boards in the United States. At each stage of production Samsung would have to convert its base currency into different currencies in order to purchase the parts required. This moves the Foreign exchange market.
  • Speculators and Individual Investors

    This is where we come in! We are simply known as ‘Retail traders’ - often referred to as ‘Individual Traders’ as we buy or sell securities for personal accounts.

    The majority of market movement comes from the Large companies and Super Banks. Our aim is to get into the market at the right point in order to be taken with the market movement created by the large institutions.

When Can It Be Traded?

The Forex Market can be broken up into 4 main trading sessions. (see diagram below)

What Are The Best Times to Trade?

A Trading Zone overlap is when two trading zones cross over each other. During this period, the markets tend to be the most volatile and liquid.

The London/New York crossover is when the markets become really interesting! Traders from the two largest financial centres in the world begin to trade (14:00-16:30pm GMT).

This is especially volatile when political news is released surrounding the United States Dollar and Canadian Dollar.

To check this news use: forexfactory.com and focus on the news that flags red - this news will create the most volatility!

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