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Foreign Exchange (Forex)

What is Foreign Exchange (Forex) ?

The Foreign Exchange Market, “Forex” or “FX” is a global electronic multi-network of banks, brokers, institutions, and individual investors for trading international currencies. The forex market is the largest, most liquid decentralized or over the counter market in the world with trillions of dollars daily turnover. 

Key Takeaways

✓ Forex is decentralized or over the counter foreign exchange market. It includes all aspects of buying, selling and exchanging global currencies.
✓ Foreign exchange venues comprise the largest securities market in the world by nominal value with trillions of dollars changing hands 24/5.
✓ The forex market is the biggest and most liquid market in the world with daily trading volume of over $6.6 trillion.

Understanding Foreign Exchange

✓ Exchange Rate – The market determines the value, also known as an exchange rate of the of currencies. International currencies are listed in pairs, for an example the euro versus the U.S. dollar represented as a currency pair EUR/USD. There is a price associated with the pair, for an example the exchange rate 1.2345. It means that the value to buy one euro costs USD 1.2345. If the price increases to 1.3445, then it now costs USD 1.3445 to buy one EUR. The EUR is increased in value (USD decreased) because it now costs more USD to buy one EUR.

✓ Lots – Currencies are trade in lots in the forex market , called micro, mini, and standard lots. A micro lot is 1,000 worth of a given currency, a mini lot is 10,000, and a standard lot is 100,000. For example, you can trade seven micro lots (7,000), three mini lots (30,000), or 75 standard lots (7,500,000).

The foreign exchange market daily turnover averaged $6.6 trillion according to the Bank for International Settlements. The main function is to represent the monetary and financial responsibility unified by 63 Central Banks. The largest trading centers are Frankfurt, London, New York, Hong Kong, and Tokyo.

Trading in the Foreign Exchange Market

The market is open for trade 24 hours a day, five days a week across major financial centers across the globe except in the weekends.

The foreign exchange was once a concept for governments, large companies, and hedge funds. In today’s world, trading currencies is as easy as a click of a mouse. It is accessible to anyone. It takes less that a minute to open an accounts and trade currencies provided to individual traders by FxPro.

Trading in the forex market is simple. You basically buy or sell the currency of a particular country. There’s no physical exchange of money from one hand to another. If you are a tourist from Europe visiting Times Square in New York City, U.S. You have to exchange your euros to actual U.S. dollar in cash while you’re traveling.

In the world of electronic markets, traders are usually take a position in a specific currency in milliseconds. You buy a currency calculating a strength in the currency on the market or sell a currency calculating a weakness so you can make a profit.

Example of Foreign Exchange

A trader expects that the European Central Bank (ECB) will be easing its monetary policy in the coming months as the Eurozone’s economy slows. As a result, the trader takes a position that the euro will fall against the U.S. dollar and sells short €100,000 at an exchange rate of 1.1500. Over the next several weeks the ECB signals that it may indeed ease its monetary policy. That causes the exchange rate for the euro to fall to 1.1000 versus the dollar. It creates a profit for the trader of $5,000.

By taking a short position of €100,000, the trader took in $115,000 for the short sale. When the euro fell, and the trader covered the short position, it cost the trader only $110,000 to repurchase the currency. The difference between the money received on the short-sale and the buy to cover it is the profit. 

How Big is the Foreign Exchange Market ?

According to the latest triennial survey conducted by the Bank for International Settlements (BIS), trading in foreign exchange markets averaged $6.6 trillion per day. The largest forex trading centers are Frankfurt, London, New York, and Tokyo.

The Bottom Line

The forex market gives the opportunity to buy the currency of a particular country and simultaneously sell the currency of another country. There’s no physical exchange of money from one hand to another. Traders usually take a position in a specific currency with the strategy that there will be some strength in the currency in respect of the other currency to make a profit. In today’s world of electronic markets, trading currencies is as easy as a click of a mouse.

Section: Forex Guide
Published: 01.01.2022
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