Forex, fully known as foreign exchange, is the world’s largest market where all currencies of the world are traded. Find here our guide on What is Forex Trading!
What Is Forex Trading?
Up to $5.3 trillion is traded on the forex market, making it the most liquid market globally. Forex trading lets you buy and sell any world currency 24/7. This article will explain the concept of forex trading and some of its advantages.
What happens when you trade forex?
Forex trading involves trading on the foreign exchange market, an activity that can be undertaken by both speculators and investors.
To understand what forex trading entails, picture a scenario where the value of the British Pound sterling is expected to weaken against the US dollar. To benefit from the market, a trader will sell the pound and buy the dollar. If the value of the dollar strengthens, its purchasing power to buy pounds equally increases. This means that the trader can buy back more pounds than they initially had and therefore they are able to make a profit.
Just like in stock trading, traders purchase a stock if they anticipate a future rise in its value and sell a stock if they anticipate a future decline in the stock’s value. In this same way, investors who trade forex will purchase a currency pair if they think the exchange rate will increase in future and sell if they expect the exchange rate to tumble.
Understanding forex exchange rates
Even if you are new to forex trading, you might have heard the term “exchange rate”. The forex market is seen as a decentralized market—this means that the market does not have a central depository where traders can transact. On the contrary, various market players carry out all forex transactions globally.
At any given point, no two currencies can have the same value. Even when such a rare occurrence takes place, it only lasts for a short time. As such, the exchange rate between two currencies always changes.
Here’s another example to help you understand the concept of exchange rates: On September 16, 2015 the value of one pound was approximately $1.55 and by September 16, 2016 the value of the pound was about $1.37. This means that the value of the pound decreased by an estimated 11% against the dollar in this period.
Fluctuations in the demand and supply of a particular currency can have implications for its value. So, when there is an increases in the supply of a currency or a decrease in demand for this currency, its value will fall. If there is a decrease in supply or an increase in demand for a currency, its value will increase.
Forex trading lets you purchase or sell any type of currency combination, also known as currency pairs, as long as these currencies are available. Based on market events, you may choose to sell or buy a certain currency in exchange for another. For example, if the US economy is predicted to become stronger, then you may buy more dollars and sell pounds. In other words, you would have sold the GBP/USD currency pair.
While other financial markets speak of a bear market, there is no bear market in forex trading — you can make profits or incur losses based on market trends.
In summary, forex trading involves the buying and selling of world currencies with the goal of making a profit. Traders may choose to sell or buy any currency pair they may be interested in depending on their investment objectives. Even then, it is ultimately important to understand how domestic and global events affect exchange rates to be able to really reap the benefits of foreign exchange trading.