What is the Foreign Exchange Market?
Foreign Exchange, most commonly known as the FX or Forex market, as a decentralized worldwide market, is an arena where one currency is exchanged for another. This market operates around the clock which basically means that it functions 24 hours a day for 5.5 days a week, opening on a Sunday afternoon and closing on a Friday, together with the New York market. As of today, Forex market is the largest and most liquid financial market in the world as it speaks of an enormous average of $5 trillion as its daily trading volume (or quite simply, the number of currencies traded), way larger than the stock exchange, which only amounts to $7.2 billion to $22.4 billion per day. Different from a regulated stock market, the foreign exchange market is unregulated and unorganized, or Over-the-Counter (OTC) market. There is no physical location and no central exchange as there are no intermediaries. Transactions are closed by virtue of private contracts made between parties.
More importantly, the forex market deals with a wide array of participants ranging from central banks, multinational corporations, financial institutions, investment managers and hedge funds, to individual investors. Forex bank or usually referred to as interbank, among all others, is a key player in the forex market as it is where the most volume of currency is traded. In other words, trading of currencies between banks of all shapes and sizes are conducted through electronic networks. It is at this point where the so-called “electronification” becomes increasingly important.
How Does it Work?
As identified first by an ISO currency code, currencies are further classified as the “base” currency and the “quote” currency or the currency being quoted which necessarily includes the price of currency pairs (the quotation of two different currencies). Foreign exchange is done using currency pairs such as the EUR/USD (Euro/US Dollar), two of the world’s most representative currencies. This implies that we are looking at the value of one currency unit versus the unit of another currency.
To further illustrate, if you buy or sell EUR/USD, it is the first quoted currency in the currency pair. It goes with your speculation that the Euro will go up and correspondingly, the US Dollar will fall. In other words, the value of the Euro is going to increase against the US Dollar. If you thought, on the other hand, that the Euro had gone up too far and the market is going to fall, the next question is: how will you profit from it? You will then sell the Euro against the US Dollar. Now, you are already speculating that the value of the Euro is going to drop.
A rule of thumb in foreign exchange is when you are buying and selling currencies, the first quoted currency in the currency pair is the same currency that you will either be buying or selling against the other and vice versa.
It is a universally acknowledged fact that forex market is inherently risky. As a matter of fact, forex exchange has a massive failure rate. Statistics suggest that 90% of traders lose almost 90% of their capital in a matter of 90 days. All those risks involved with it yet people are continually drawn to it. Why?
One answer would suffice: every decision made by a wise trader is a risk rooted in determination and persistence, not on whims and caprice. Hand in hand with that risk of bigger losses gives the potential to own and possibly multiply substantial profits. Any wise trader would know that you have to experience a steep learning curve in order to be successful. Only the braveheart would dare to venture such an undertaking. Well, it’s down to you as a trader at the end of the day. Good luck.