What is Forex and how exactly does it work?

So what is Forex? To put it simply, it is a global market that allows traders to exchange one currency for another. Most people have used more than one currency at the same time. For instance, you go on holiday and exchange your home currency for the country which you are traveling to at the airport.

Key factors in the the forex market - image for article 49939
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When at the currency exchange kiosk, you should see a table of exchange rates for the different currencies that are offered.

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The chart will display how much your currency is worth in relation to another country’s currency. So you may see the Japanese Yen figure and think that your one US dollar is worth 100 yen and you are instantly much richer in the country that you are visiting. By exchanging your currency, you are participating in the Forex market, simply by exchanging one currency for another.

In the Forex world – rates change all the time

In Forex terms, if you are an American visiting Japan, then you’ve sold your dollars and bought the Japanese Yen. Once you exchange your currency, you may notice that the next time you try to get your dollars back, the rate has changed. It is the change in exchange rates that allow Forex traders to make money in the foreign exchange markets.

The foreign exchange market, often referred to as the FX or Forex market is the largest financial market by a large margin. For comparison, the New York Stock Exchange has a daily volume of $22.4 billion, with the Forex market boasting a daily trading volume of $5 trillion. The New York stock exchange is the largest stock market, with the Tokyo and London Stock Exchange having a daily trading volume of $18.9 billion and $7.2 billion respectively.

A massive market

The currency market is well over 200 times bigger than the stock market.

One of the other big differences between the Forex market and the stock market is that the FX market doesn’t close at the end of the day. Instead of closing, the foreign exchange market shifts to different financial centers all around the world. At the start of the day, traders wake up in Sydney, then Tokyo, London, Frankfurt, and then New York, before starting again in Sydney.

Forex traders buy and sell money

Despite knowing what the Forex markets are, it may still be difficult to understand what exactly is being traded. In short, the answer is money. Unlike stocks and shares, you are not purchasing anything physical like equity, so this can make Forex trading difficult for some people to understand.

When you buy currency, think of it like you are buying shares in a country, similar to buying stock in a company. The price of a currency is determined by many factors, such as the current and long-term health of a country’s economy as well as trader sentiment.

The aim – to sell for more than you paid

The way retail investors make money trading currency is by buying lower than the price they are hoping to sell it at. So, you hope that the pair which you have purchased will appreciate at price, as it means you will make a profit when it comes time to sell the pair.

There are many different currencies that get used around the world, but when you start trading, you are only likely to be trading the major currencies. There are eight major currencies that you are likely to trade, this includes US dollar, Euro, Yen, Pound, Franc, Canadian Dollar, Australian Dollar, and New Zealand Dollar.

To find out more about trading forex, take part in online courses and research using books and online news sources. It can be argued that success in the FX markets is more obtainable than success in stock markets due to the lower amount of capital required.

Interesting related article: “What is the Foreign Exchange Market?