What is Forex Trading?
Forex market is very different to other financial markets you may have experienced. It is highly leveraged and very volatile with opportunities to trade 24/6 days excluding Saturdays. The word “Forex or forex trading” was derived from FOReign EXchange. Though, it is also referred to as FX or currency market, but forex trading popularity came to light when the US government opened up its retail market over a decade ago.
That simple gesture meant you can now play with the big boys. You can now swim in the big waters with the big fishes and all its dangers. In forex trading for example, when you place a trade you are opening two positions at the same time – one to buy a one currency while selling another.
What people tend to forget is that ‘there are no guarantees’. You may not know whether your predicted outcome would be realized and that is what makes forex trading a speculative market.
Understanding Forex Trading
Forex is traded by a network of Central Banks, large commercial firms, investment banking institutions, brokerage firms, pension fund managers, hedge funds and private traders.
It is driven by the need for companies to provide international goods and services to one another in the global market place.
Currencies trade in pairs, like the Euro-US Dollar (EURUSD) or US Dollar / Japanese Yen (USDJPY). Forex trading is used to speculate on the relative strength of one currency against another. The foreign exchange market is an over-the-counter market, which means that it is a decentralised market with no central exchange. The forex market is not regulated by any single country or regional powers.
Who trade currencies?
Daily turnover in the world’s currencies comes from two sources:
* Foreign trade (5%)
* Speculation for profit (95%).
Most traders focus on the biggest, most liquid currency pairs. “The Majors” include US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar. In fact, more than 85% of daily Forex trading happens in the major currency pairs.
The world’s most traded market, trading 24 hours a day
With average daily turnover of $6.15 trillion, (source: BIS, 2009 report) forex market is the most traded market in the world and it’s a true 24-hour market from Sunday 10 PM GMT to Friday 10 PM GMT. Forex trading begins in Sydney, Australia because it is the first financial market to open. Then the three major cities: Japan, London and New York.
Unlike other financial markets, it’s a market where traders could trade money for money. Is it difficult to see why there is so much liquidity? Better still, traders can respond immediately to currency fluctuations, whenever they occur – day or night.
For example, say a Nigerian company, Nestle wants to buy cocoa from Ghana and needs to pay Ghanian farmers in Cedis but have Naira. To carry out this transaction, Nestle would need to work out the Naira-Dollar and the Dollar-Cedis equivalence in the international market. This value is what Nestle would pay in Cedis to complete the transaction.
Did you notice that whilst the conversion was taking place that a forex trading opportunities also developed? This is one why many of these multi-national companies are major players in the forex market.
Suppose Nestle isn’t buying cocoa right now but Cedis on the other hand is cheap currency ot the moment. Nothing stops Nestle from buying Cedis against cocoa future order. If Cedis should appreciate from where it was bought against the dollar or Naira equivalence, Nestle would have gained. But if the opposite is true they lose money. This is why you’ll find that companies like Toyota, BMW and many others could report more forex market than trading for car-sale. [2001 Report].
In same way, forex traders may not have the same need for currency exchange, but to speculate for profits on the rise and fall of one currency exchange rate to another. Trading this spreads from currencies rise-fall is what creates the huge financial risk-reward. This is what creates the huge volatility for profit and losses in the market as highlighted above.
A Word of Warning
To succeed in forex trading, you must be disciplined, focused and possess good money management strategy. These attributes and skills could also be learnt if you are determined to succeed in forex trading. Forex trading has no place for sentiments and emotion. Neither is it a place to make quick bucks because you are broke as some might have you believe. Spend time honing your skills. No matter what price you might have paid but it will be worth it in the end if you are dedicated and committed to it.
More Information
See your local Central bank or Reserve Bank. We hope you have gained some knowledge in this explanation. Please leave your comments below.
I would be interested to hear more. Great post.
A bit surrpsied it seems too simple and yet useful.
Thanks for your post Bertha. Most things usually are but human efforts get in the way and mess things up. Persistency usually help.
Thanks for the share!
Nancy.R
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