Home/Blogs/What Is Forex Trading & How Does It Work

What Is Forex Trading & How Does It Work

26 May 2023

What is forex trading all about? Every traveller has, at some point or another, exchanged one currency for another. Forex is the short form of foreign exchange, and it translates to one currency being exchanged for another, just as lay people know. However, in the world of trading and investment, forex trading and other aspects of it need some further clarity. 

What is Forex Trading? Some Basics of the Forex Market

The transaction of one currency being exchanged for another is termed foreign exchange or forex. This kind of transaction may be conducted for any one of several reasons, like enabling global trade or the purpose of commercial tourism. In terms of trading and making a profit out of forex, forex trading occurs in forex markets. These are open for the purchase and sale of currencies all day (24 hours). The markets are prepared for trading all five working days in the week. 

Key players in forex markets include investment management firms, businesses, retail traders and hedge funds. To trade in the currency markets, individuals should grasp how the forex market works. Although forex markets are the most active trading places compared to other markets, they are equally risky. They are the most liquid too, and conduct a trading volume of around $5 trillion daily. 

How Does Trading Work?

Forex also goes by the acronym “FX”. When you talk of stock trading, you know you have to open a Demat account and buy and sell stocks on the stock exchange. You either make profits or losses based on the way the price of a stock moves. In currency trading, or forex trading, you trade one currency against another. The profits and losses you make in forex trading depend on the value of one currency vis a vis another in a pair. This is technically how the forex market works, and trading occurs. Technically, traders, by way of buying or selling one currency against another, are converting one currency into the other. Trading happens on currency exchanges on an international scale. 

A Unique Market

Understanding stock investment and even how to invest in any upcoming IPO may be child’s play to you compared to the understanding of currency markets. However, if you have specific knowledge about forex markets, you can easily gauge how trading occurs. A distinctive aspect of the forex market is that it is truly international in nature, and there is no central or single marketplace regarding forex. Instead, currencies are traded electronically via OTC or over-the-counter trades. This translates to the fact that most transactions occur through networks of computers with a vast number of traders all over the globe. When you ask, “What is forex trading?”, you may get an answer that reflects the idea of an international and very enormous trading platform for the exchange of currencies. 

Primary financial centers that partake in forex trading are New York, London, Hong Kong, Tokyo, Zurich, Paris, Singapore, and Sydney. These trade across time zones. So, for instance, when the forex trading day in the US closes, the currency markets start in Hong Kong and Tokyo. As such, the market of forex is an extremely active market at any time, and quotes of prices are bound to keep changing. 

The Way Currencies are Traded

The majority of trade in the forex markets happens among institutional traders. These are individuals who work as fund managers or work for banks. Institutional traders also comprise a vast number of multinational organizations. The intention of such traders is not to physically possess currencies themselves; what they may do is just speculate about or hedge against the future rate of exchange fluctuations. For instance, a speculative trader could buy US dollars (USD) and sell euros (EUR) if they think the dollar will become more robust (in value) and, therefore, be able to buy euros in a greater amount in the future. So, if you have got some answers to the question, “What is forex trading?” and how it essentially works, you may want some more information. 

The Currencies and Trading Activity

In forex trading, all currencies have an assigned three-letter code. Some examples of codes are the EUR (Euro), USD (US dollar), JPY (Japanese Yen), AUD (Australian Dollar), CAD (Canadian Dollar) and GBP (British Pound). Today, there are around 170 currencies, but only a few are involved in forex. The vast majority of trading is conducted with one of the strongest currencies in the world - the USD or the US dollar. Besides this, the euro is the next most traded and accepted in 19 countries within the European Union. When you start your forex trading career, you should know that all currencies are traded in “currency pairs”, with one of any pair being exchanged for the other. Approximately 75% of trading within forex occurs with the pairs listed below: 

  • USD/JPY
  • EUR/USD
  • GBP/USD
  • AUD/USD
  • USD/CAD

The key to grasping how the forex market works is to know about currency pairs and, specifically, how different factors affect each currency in a single pair. For instance, if you are trading the EUR/USD pair, you should know the following: 

  • The EUR (euro) placed on the left is the “base” currency. 
  • The USD (US dollar) on the right is the “quote” currency. 
  • The exchange rate refers to how much of the USD (quote currency) is required to purchase a unit of the EUR (base currency). Therefore, the base currency is always expressed as a single unit, or one unit, while the quote currency changes and is dependent on the present conditions of the market. 
  • In the simplest terms, assuming the EUR/USD rate of exchange is 1.3, it means that €1 can buy $1.30. To put this another way, it will cost a trader 1.30 USD to buy 1 euro. 
  • If and when the exchange rate goes up, this translates to the base currency rising in value compared to the quote currency (so, in the example above, 1 euro can buy a greater amount of US dollars). 
  • Traders may have different objectives and hence, trade in different ways. These include the spot market, where traders just swap currency pairs in real-time. Traders may also trade in a forward market where contracts about prices are entered. For example, traders are permitted to lock in a rate of exchange for a future trading date. Then there are futures contracts in which trades may take place according to a contract but for a specific amount and on a particular date. 

Get Your Forex Moves Right

So, what is forex trading, after all? By now, you know the answers you need to begin, but it is always good to do some further study on your own. You may have already gauged that you do not need to open a Demat account to trade in currency. While you do some exploration in the forex markets, you may come across an upcoming IPO to invest in and diversify your current portfolio

 

Checkout more Blogs

You may also like…

Get Exclusive Updates

Be the first to read our new blogs

Intelligent investment insights delivered to your inbox, for Free, daily!

Open Demat Account
I wish to talk in South Indian language
By proceeding you’re agree to our T&C
Click here to see your activities