Thursday, March 19, 2009

What is Forex

Forex is short for foreign exchange, also known as FX or currency trading. Trading one currency against another (a base currency and a counter currency making it a pair).
Traders, hedge funds and financial institutions speculate in the forex markets with the goal in mind to make a profit or international companies for example to pay wages, buying or selling their products or services in another country. Forex is the largest market in the world.
It was estimated in April 2007 that the average of global foreign exchange markets reached $3.98 trillion a day and that the main financial markets  accounted $3.21 trillion of this! These numbers are huge and are still growing.

  • $1,005 billion related to spot transactions
  • $362 billion for outright forwards
  • $1,714 billion related to forex swaps
  • $129 billion estimated gaps in reporting

About $2.1 trillion was traded in derivative securities (an agreement by two parties to buy or sell an asset, meaning currencies).

And remember, this was in 2007, since then the forex markets only have grown bigger because the world economy has expanded and more and more options opened up (and still are) to trade currencies also largely thanks to the internet.

Forex trades 24 hours a day every day, 52 weeks a year, even on holidays with a brief close on weekends (Friday 1:00pm, when the New York closes until the open on Sunday at 2:00 pm (PST), when trading in Wellington, New Zealand begins.

A little history about Forex

The Forex market as we know it today isn't that old. It wasn't until 1971 when President Nixon suspended the gold convertibility that was fixing the US dollar at USD35/oz and fixing the other main currencies to the US dollar.
A previous system (that was supposed to be forever) no longer worked. It was a system setup during WWII to prevent monetary destabilization from happening because that ultimately caused the war. But that system came under pressure in the sixties when world economies moved into different directions and the US deficit was building up, so the old system no longer worked. Currencies were no longer pegged to gold but could flow freely against each other, resulting in something that would become the largest trading market on the planet.
Forex was born.

 

Location of Forex

The foreign exchange market is a global over the counter (OTC) market and does not have a centralized place. Trading is done by:

  • Central Banks
  • Commercial Businesses
  • Banks
  • Retail Forex brokers

 

A forex quote looks something like this, for example; EUR/USD meaning the EUR is the base currency and the USD the counter currency. In other words you are trading the US dollar against the Euro. So is you think the value of the Euro will go up (you're bullish on the Euro) you will be buying Euro's against the US Dollar, and vice versa.
If for example the EUR/USD quote is 1.36 it means that €1.00 Euro is worth US $1.36.

Major currencies:

There are 8 major currencies in the world, also called, you guessed it, the majors. These are likely the currencies you will be trading if you decide to trade Forex.

They are:

USD = United States Dollar (also known as the Buck)
EUR = The Euro currency (also known as the Fiber)
GBP = Great Britain Pound (also known as the Cable)
CHF = The Swiss Franc (also known as the Swissy)
AUD = Australian Dollar (also known as the Aussie)
CAD = The Canadian Dollar (also known as the Loonie)
NZD = New Zealand Dollar (also known as the Kiwi)
JPY = The Japanese Yen (also known as eeeh, the Yen)

Commodity currencies:

The 3 major commodity currencies are the CAD, AUD and the NZD because their countries depend heavily on exports of raw materials.

Cross currencies

Anything that doesn't involve the USD is called cross currencies, for example GBP/JPY. Currencies that involves the Euro is called Euro crosses, like EUR/GBP.

next: how to trade forex

Disclaimer:

All opinions expressed, trade recommendations/advice on this website are solely of John van der Munnik and are not affiliated with any investment firm or any other organization. You should not make an investment only based using this website VDM Trading for your trading needs without seeking help from your own financial advisor.