Learn Forex - Lesson 1 - What is Forex?
Foreign Exchange Market
Currency exchange has always been and still remains important for conducting business and foreign trade. How it takes place and how the foreign exchange market actually works interests many people. And in order to exactly understand the essence and functions of the market, we should firstly reveal how it is formed and what it stands for.
History of Forex Market
The history of Forex market is marked by two particular events which put a deep stamp on its formation and development. These two historical events are the creation of Gold Standard System and Bretton Woods System.
Gold Standard and Bretton Woods Systems
Gold Standard System was formed in 1875. The main idea behind it was that governments guaranteed that a currency would be backed by gold. All the major economic countries defined an amount of currency to an ounce of gold as the value of their currencies in terms of gold and the ratios for these amounts became the exchange rates for these currencies. This marked the first standardized means of currency exchange in history. However, World War I caused a breakdown of the gold standard system as countries sought to pursue economic policies which would not be constrained by the fixed exchange rate system of the Gold Standard.
In July 1944 more than 700 representatives from the Allied nations brought forward the importance of a monetary system which would fill the gap left behind the gold standard. They arranged a meeting at Bretton Woods, New Hampshire, to set up a system that would be called the Bretton Woods system of international monetary management. The creation of Bretton Woods System led to the formation of fixed exchange rates as the United States defined the value of US dollar in terms of gold equal to $ 35 for one ounce and other countries pegged their currencies to the dollar. The US dollar became the main reserve currency and the only currency that was backed by gold. However, in 1970 the U.S. gold reserves were so depleted that it was impossible for the U.S. treasury to cover all the reserves held by foreign central banks.
In August 1971 the U.S. announced it would no longer exchange gold for the U.S. dollars that foreign central banks had in reserve .This was the end of Bretton Woods System and the beginning of Forex Trading System.
What is Forex Market?
The foreign exchange market, also known as “Forex” or “Fx” market, is a global decentralized marketplace where currencies are traded. It has no centralized marketplace where transactions are conducted. Rather, Forex trading is carried out electronically over-the-counter (OTC), meaning that all trading transactions are performed via computer by traders and other market participants over the world.
The foreign exchange market is the largest financial market in the world where the average daily turnover is continuously growing. Daily turnover of conversion transactions in the world is estimated at $4 trillion, 80% of which are based on speculative transactions with the intention to get profit from trading the exchange rate differences.
This kind of market scale means that the market liquidity, the amount of buying and selling volume occurring at a particular time, is extremely high. This is a very important factor that allows to easily buy and sell currencies, and especially from an investor’s perspective, to determine how easily the currency price can change over a certain time period.
How to Trade on Forex Market
The trade that takes place in Foreign exchange market involves simultaneously the buying of one currency and the selling of another. This is because the value of one currency is relative to the other currency and is determined by their comparison. From a retail trader’s perspective Forex trading is the speculation on the value of one currency relative to another.
Each currency pair can be thought of a single unit consisting of a “base currency” (the first currency) and a “counter (or quoted) currency” (the second currency) which can be bought or sold. It shows how much of the counter currency is needed to buy one unit of the base currency. So, in the EUR/USD currency pair EUR is the base currency and USD is the counter currency. If you expect the price of Euro to increase against the price of the U.S. dollar you can buy the EUR/USD currency pair. While buying a currency pair (going long) the base currency (EUR) is being bought, whereas the counter currency (USD) is being sold. Thus, you buy the EUR/USD currency pair at a lower price to later sell it at a higher price and as a result make a profit. If you expect the opposite situation, you can sell the currency pair (go short), meaning sell Euro and buy the U.S. dollar.
However, the risk is always there. If you buy Euro against the U.S. dollar, expecting that Euro is going to rise in price, but instead the U.S. dollar strengthens, you will then suffer losses. So, besides the benefit that you can make from trading, you should always consider the risk involved in it.
As you could see the foreign exchange market is not so complex to understand and not so dangerous to enter. You can become one of its participants in a few minutes and start earning money more than easily. How to learn Forex trading and specifically how to use the online trading platform are thoroughly presented on our website. You can read our educational materials and trading e-books which will help you understand the essence of Forex trading, discover its benefits, learn how to trade effectively and how to manage your risk.
Forex Market Hours
The foreign exchange market is extremely active all day long with price quotes constantly changing. It is the only market that truly operates 24 hours a day and five days a week. Currencies are traded in the largest stock exchanges and marketplaces all over the world: in Zurich, Hong Kong, New York, Tokyo, Frankfurt, London, Sydney and Paris. This means that across almost every time zone the market is active - when the market closes in the U.S. the trading day starts in Tokyo and Hong Kong.
The time flexibility is very convenient for traders who have a busy working schedule. They do not need to worry about market opening and closing hours and are free to arrange their trade anytime they want.
The chart below provides the working hours of major marketplaces.
Forex Market Participants
Foreign exchange market is composed of different participants, also called Forex market players, who trade on the market for quite various reasons. This means that participating in Forex market transactions does not take place simply for speculative purpose. Each of the participants plays its own role in the market providing the latter’s wholeness and stability.
The main players of the market are:
- Governments and Central Banks
- Commercial banks and companies
- Hedge funds
- Brokerage companies
- Retail Forex traders