What is forex?
Forex, also known as the foreign exchange market, is the conversion from one currency to another. It is one of the most active markets in the world, with an average daily trading volume of $ 5 trillion. Learn more about what forex is, how the forex market works, and how forex leverage works.
A large number of operations are carried out for practical reasons, but the vast majority of currency conversions are carried out by investors with the aim of obtaining profits. The amount of currencies converted on a daily basis can cause the price movements of some of them to be extremely volatile. It is precisely this volatility that makes forex so attractive to investors: it provides greater opportunities to maximize profit, but it also increases risk.
How does the currency market work?
Unlike stocks or commodities, forex trading is not done in markets, but is traded directly between two parties in an over the counter (OTC) market. The forex market is established through a global network of banks, spread over four main centers in different time zones: London, New York, Sydney and Tokyo. As there is no physical place through which trades are processed, you can invest in forex 24 hours a day.
There are three different types of forex markets:
Forex spot market: it is the physical exchange of the currency pair, which takes place at the exact moment in which the operation is settled or after a small margin of time
Forex forward market: a contract is established to buy or sell a fixed amount of currency at a certain price, and whose expiration is made on a future date established or within an interval of future dates
Forex futures market: a contract is agreed to buy or sell a certain amount of a certain currency at a set price, on a fixed date in the future. Unlike a forward, a futures contract is legally binding
Most forex investors are not interested in receiving the physical delivery of the currency, but instead make predictions about exchange rates in order to profit from price movements in the market.
What is a first currency?
A first currency is the one that precedes the pair, while the next is called the second currency. Forex trading always involves buying one currency and selling another, which is why they are listed as pairs: the price of a pair is determined by calculating how much a unit of the first currency is worth in the second currency.
The currencies of a pair are identified by a three-letter code, in which normally the first two correspond to the region and the third to the currency itself. For example, GBP / USD is a pair made up of the British pound and the US dollar.
Most providers classify currency pairs into the following categories:
Senior couple. These are the seven pairs that make up 80% of global forex trading, and among which are the EUR / USD, USD / JPY, GBP / USD and USD / CHF
Minor pairs. These are traded less frequently, and typically contain major currencies other than the US dollar. Includes EUR / GBP, EUR / CHF and GBP / JPY
Exotic pairs. They are made up of a major currency versus another in a small or emerging economy. Includes USD / PLN, GBP / MXN and EUR / CZK
Regional peers. These are pairs classified by region, such as Scandinavia or Australasia. Includes EUR / NOK, AUD / NZD and AUS / SGD
How does the forex market move?
The forex market is made up of currencies from around the world, and the number of factors that can affect price movements makes predictions about exchange rates difficult. However, like most financial markets, forex is primarily affected by the laws of supply and demand, and it is important to understand what and how price fluctuations are caused.
Central banks control supply, and can take actions that significantly affect the price of their currency. Quantitative easing, for example, involves pumping money into an economy, which can cause the price of the currency to fall.
Commercial banks and other investors tend to deposit their capital in economies with good prospects. Therefore, if the markets echo positive news about a certain region, this will motivate investment and cause an increase in demand for the regional currency.
Unless there is a parallel increase in the supply of that currency, the difference between supply and demand will cause its price to rise. Similarly, negative news can mean a brake on investment and a decline in the price of the currency. For this reason, coins often reflect the economic health of the region they represent.
Market confidence, which is often news-related, can also play a major role in the movement of currency prices. If investors believe that a currency is going to move in a certain direction, they will invest accordingly and can convince others, thus causing demand to rise or fall.