What Is Forex Trading? An Introduction To Forex

Forex, or foreign exchange, or FX is actually quite a simple thing to understand. Anybody who has travelled overseas has probably had to go to a money changer and change your local currency into the currency of the country you are going to be spending in.

When you make that change, from maybe USD to Australian Dollars or any other currency, you’ve essentially participated in a Forex transaction.

When you trade back from the Australian Dollar to the USD, there may have been a slight change in exchange rates over the time you were travelling, it might have increased, it might have decreased.

These fluctuations in exchange rates are what allows you to make money in the Forex market.

What’s so big about the Forex market I hear you ask?

Well if you put it into comparison or perspective, the NYSE, the bid-daddy of stock exchanges, trades roughly $74 Billion a day in volume. This may sound like a lot, but in comparison to the Forex market, it’s barely a drop in the bucket.

The FX marketing trades an unbelievable $4 Trillion a day in volume!

But most people know much more about the NYSE than they’ll ever know about the FX market, since it’s so widely covered on almost every single major news channel on a daily basis, from CNN, CNBC to Bloombery and BBC.

But when it comes to sheer volume traded, you can’t beat Forex.

Check out the graph below to see a comparison in the difference of the most popular stock exchanges around the world:

[Source: Babypips.com]

What Is The Size Of The Forex Market?

Another thing people don’t typically know about the forex market is that unlike the NYSE, or KLCI, which both have physical locations for their activities, the forex market has no central exchange or location.

Known as an ‘Over The Counter’ (OTC) market, or ‘interbank’ market, all forex trading is essentially run completely electronically, through a large network of banks, 24/7, 365 days a year. With no one location, trades can be carried out at all locations around the world and almost at all timezones.

Being one of the largest traded markets in the world by both corporations and individuals alike, trades take place on the OTC market depending on a number of factors, including socio-economic variables, price, reputation etc.

But by far the most traded currency on the forex market, making up almost 85% of all transactions is the US dollar, followed by the Euro at almost 40%, then yen at about 20% and the remainder made up by some other currencies spread across the world.

Something important to keep in mind is that the are always 2 sides of a trade, one side, which is usually the US dollar, and the currency that you are trading to, which can be referred to as a pair.

The Importance Of The US Dollar

The US dollar or USD for short, makes up almost one half of almost every major currency pair on the market, and the major currencies themselves make up 70%+ of all trades. So you can see just how important it is in relation to Forex trading in general.

The USD is said to make up more than half of the world’s entire foreign exchange reserves – just think about that, more than half of the world’s foreign reserves are held in a single currency!

So the USD should be something all would-be Forex traders should pay big attention to.

How Is Forex Traded Upon – About Speculation.

Although most trades on the forex market are done for commercial (such as purchasing of goods) and financial (such as money changers and banks), most of the trades are done based on speculation. That means short term traders are very common, trading on price movements on a day to day basis, or even hour to hour and shorter periods.

That means that the forex market is a highly liquid beast, since there are people willing to trade at almost any specific time of the day, buying and selling currency is possible within a very short period and makes it easy for anyone to get into it.

NB: On the flip side, this also means that not only is it easy to invest, easy for prices to go up (and hence make money), it is also easy for money to be lost. This risk needs to be understood by anyone reading this and if you have a low level of risk tolerance, Forex trading is probably not for you.

There are ways to manage this risk, but inherently you must be prepared to take on the risks for the rewards, so it isn’t for everybody.

How Do You Trade Forex?

There are a variety of ways to trade in foreign currencies, mainly forex spot market, futures, options and exchange-traded funds (ETF). In their simplest form, each of these methods can be understood as:

• Spot Market – Currencies can be traded on the ‘spot’ using the prevailing market price. The simplicity and liquidity of this market and because you can trade all times of the day make it a very popular choice.
• Futures – Similar to futures in stock trading, in forex it works the same, where you can buy or sell contracts on forex prices on a future date. The market is well regulated and information on it is readily available
• Options – This gives the buyer the ‘option’ to buy or sell an asset at a price on the expiry date of the option. If you enact your option, then you have buy or sell your asset at the price determined for the expiration date.
• Exchange Traded Funds (ETF) – These are relatively new to forex and work basically by combining a selection of stocks and currencies, so that traders can have a wider range/ diversified asset classes in their portfolio. However, because stocks are involved, you can’t trade 24 hours a day, you need to follow the exchanges’ opening hours.

This simple introduction was meant to provide you a quick overview of some of the terms and basic knowledge required to start gaining knowledge in the forex market. Our next article will cover topics such as the advantages of Forex and the currencies used in forex.

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