What is Forex?

History of the Forex market

Prior to 1971, speculation was not permitted in the currency markets due to an agreement called the Bretton Woods Agreement. This agreement was set up in 1945 with the purpose of stabilizing international currencies and preventing money from fleeing across nations. This agreement fixed all national currencies against the dollar and set the dollar at a rate of $35 per ounce of gold.

In 1971, the Bretton Woods agreement was finally abandoned and the US dollar was no longer convertible to gold. By 1973, currencies of the major industrialized nations were floating more freely, helped by the forces of supply and demand. Prices were set, with volumes, speed and price volatility, all increased during the 1970s. This paved the way to new financial instruments, market deregulation and open trade. It also led to a rise in the power of speculators.

Accelerated by the arrival of computers during the 1980s, the movement of money across borders became a continuum, trading through the Asian, European and American time zones. The big banks created dealing rooms where hundreds of millions of Dollars, Euros, Pounds, and Yen were exchanged within minutes.

London has developed to become the world’s leading international financial center and is the world’s largest Forex market. In the 1980s, it became the key center in the Eurodollar market when British banks began lending dollars as an alternative to pounds in order to maintain their leading position in global finance. London’s convenient geographical location (operating during Asian and American markets) is also instrumental in preserving its dominance in the Euro market.

Forex (Foreign Exchange)

Forex means foreign exchange. Sometimes it is also called FX. A simple way to understand the Forex market is to think of it as exchanging money when you travel abroad. When you exchange currency, you sell one currency and buy another at the current exchange rate. This is because the value of your own currency is not equal to the value of the currency you wish to buy. In effect, you have traded currency and this is very similar to Forex trading.
Currencies constantly need to be exchanged in order to conduct business. This makes the Forex market one of the largest, most liquid financial markets in the world. The daily volume of trades on the London Stock Exchange is USD 7 billion, whereas the daily volume on the Forex market was $5.3 trillion in April 2013 according to the BIS triennial report.

Where is Forex Situated?

Unlike other financial markets the Forex market has no central location or exchange. The market is so large that it is unlikely to be affected by one person or one company – it takes much bigger processes to influence the direction of the market. It works almost the same way as the internet does (World Wide Web). That means that every order from any trader is executed in a global network of demand and supply, called the ECN network (Electronic Network of Banks). That fact adds reliability and transparency into Forex trading transactions.

What is Forex Trading?

Forex trading is the simultaneous buying of one currency and the selling of another. When you trade Forex, you can trade with a broker through a trading platform. Currencies are always traded in pairs, for example, GBP/USD (trading the British pound against the US dollar). The first currency in the pair is known as the “base” currency, the second one is the “quote” currency. They are also often referred to as “buy” and “sell” or “offer” and “bid”.
Daily currency fluctuations are usually very small. Most currency pairs move less than one cent per day, representing a less than 1% change in the value of the currency. This makes foreign exchange one of the least risky financial markets in the world.

Available Currency Pairs

The “majors” and the “commodity pairs” are the most liquid and most widely traded currency pairs in the Forex market. These pairs and their combinations make up the vast majority of all trading in the Forex market. Because these pairs typically have the largest volume of buyers and sellers, they also typically will have the tightest spreads.

The four major currency pairs are:

1. EUR/USD: The euro and the U.S. dollar
2. USD/JPY: The U.S. dollar and the Japanese yen
3. GBP/USD: The British pound sterling and the U.S. dollar
4. USD/CHF: The U.S. dollar and the Swiss franc

The three Commodity Pairs are:

1. AUD/USD: The Australian Dollar and the US Dollar
2. USD/CAD: The US Dollar and the Canadian Dollar
3. NZD/USD: The New Zealand Dollar and the US Dollar

Forex Market Participants

The most important Forex market participants are:
1. Central and Commercial Banks
2. International Trade Companies
3. Forex Brokers (ECN, STP and Dealing-Desk brokers)
4. Large, Medium and Small Institutional Investors (i.e. Investment Companies, etc.)
5. Common Retail Traders
6. World Travellers

Forex Brokers

Currency traders use brokers to access the 24-hour currency market. A Forex broker is an intermediary between you and the “interbank” (networks of banks that trade with each other). Typically a Forex broker offers you a price from the banks with whom it has relationships with. Many Forex brokers use multiple banks for pricing, and they offer you the best one available. Besides, brokers provide traders with a trading platform that allows them to buy and sell foreign currencies.