Forex Trading: A Beginner's Guide
What is Forex trading? Forex is just a portmanteau of foreign currency and exchange. Foreign exchange is the procedure of changing one currency into another currency for a number of reasons, usually for commerce, trading, or tourism. According to a 2019 triennial report from the Bank for International Settlements (a global bank for national central banks), the daily trading volume for forex reached $6.6 trillion in April 2019.
What Is the Forex Market?
The foreign exchange market is where currencies are traded. Currencies are very important because enable purchase of goods and services locally and across borders. International currencies need to be exchanged to be able to conduct foreign trade and business.
If you're living in the U.S. and want to buy cheese from France, either you or the business that you buy the cheese from has to cover the French for the cheese in euros (EUR). Which means that the U.S. importer will have to exchange the equivalent value of U.S. dollars (USD) into euros. The same goes for traveling. A French tourist in Egypt can't pay in euros to begin to see the pyramids because it's not the locally accepted currency. As a result, the tourist has to change the euros for the local currency, in cases like this the Egyptian pound, at the existing exchange rate.
A Brief History of Forex
In its simplest sense, the forex market has been around for centuries. People have always exchanged or bartered goods and currencies to buy goods and services. However, the forex market, as we realize it today, is just a relatively modern invention.
Following the accord at Bretton Woods in 1971, more currencies were permitted to float freely against one another. The values of individual currencies vary predicated on demand and circulation and they're monitored by foreign exchange trading services.
An Overview of Forex Markets
The FX market is where currencies are traded. It's the only truly continuous and nonstop trading market in the world. Before, the forex market was dominated by institutional firms and large banks, who acted with respect to clients. But it has become more retail-oriented recently and traders and investors of numerous holding sizes have begun participating in it.
An interesting part of world forex markets is that there are no physical buildings that function as trading venues for the markets. Instead, it is some connections made through trading terminals and computer networks. Participants in this market are institutions, investment banks, commercial banks, and retail investors.
Forex for Hedging
Companies conducting business in foreign countries are at an increased risk due to fluctuations in currency values once they buy or sell goods and services outside of the domestic market. Foreign exchange markets provide a method to hedge currency risk by fixing an interest rate at that your transaction will be completed.
To accomplish this, a trader can purchase or sell currencies in the forward or swap markets in advance, which locks in an exchange rate. For instance, imagine a company plans to offer U.S.-made blenders in Europe once the exchange rate involving the euro and the dollar (EUR/USD) is €1 to $1 at parity.
Forex for Speculation
Factors like interest rates, trade flows, tourism, economic strength, and geopolitical risk affect supply and demand for currencies, which creates daily volatility in the forex markets. An opportunity exists to make money from changes that will increase or reduce one currency's value in comparison to another. A forecast that certain currency will weaken is essentially the same as let's assume that the other currency in the pair will strengthen because currencies are traded as pairs.
Imagine a trader who expects interest rates to increase in the U.S. in comparison to Australia while the exchange rate between both currencies (AUD/USD) is 0.71 (it takes $0.71 USD to buy $1.00 AUD). The trader believes higher interest rates in the U.S. will increase demand for USD, and therefore the AUD/USD exchange rate will fall because it will need fewer, stronger USD to buy an AUD.
Forex Trading: A Beginner's Guide
Trading currencies may be risky and complex. The interbank market has varying examples of regulation, and forex instruments are not standardized. In some elements of the planet, forex trading is almost completely unregulated.
The interbank market is made up of banks trading with each other around the world. The banks themselves have to ascertain and accept sovereign risk and credit risk, and they've established internal processes to keep themselves as safe as possible. Regulations such as this are industry-imposed for the protection of every participating bank.