Forex (FX) Basics: What is Foreign Exchange Trading and How Does It Work?

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Every country uses a particular currency. Currencies need to be exchanged if different countries wish to trade or do business with each other. The foreign exchange market is where all of this takes place. This is often referred to as forex or FX trading.

It is the biggest and the most fluid fiscal marketplace worldwide. Not even the stock market comes close to the volume of currency trades. Close to $2,000 billion (USD) in stocks is traded daily. In comparison, the foreign exchange market oversees more than $4.9 trillion per day.

When a person in the U.S. buys furniture from someone in India, the exact value in U.S. dollars has to be handed over in rupees. The same thing applies to international travelers. An Indian tourists visiting the U.S. would have to pay for a hotel room in dollars because the rupee in not the locally accepted currency.

The need to convert currency makes the forex marketplace the most valuable in the world. People and companies purchase products and services from other countries all the time.

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FX, forex and foreign exchange trading

An interesting thing about the foreign exchange market is its lack of a central location for trade. Currency exchanges are done through electronic other-the-counter transactions. Computer networks essentially oversee the the vast series of trades between foreign currencies.

Beyond that, the forex market is open every hour of each weekday and leans into the weekend too. Major financial centers are in just about every time zone worldwide. They include the central cities in almost every country, such as London, New York, Tokyo, Johannesburg, and Sydney.

This ensures the extremely high activity and liquidity for the FX market. When one marketplace closes, another opens up somewhere else in the world. That means the exchange of foreign currencies virtually takes place at all times.

Foreign exchange trading is conducted in one of three methods. People and organizations can trade currencies via the forwards market, futures market and spot market.

There was once a time when the futures markets was the most popular way of trading forex. That was because individual traders had access to the marketplace for longer periods. However, the rise in electronic trading put an end that and now the spot market holds the most popularity.

Digital trading also pushed the popularity of spot market trading for speculators. As a result, individuals recognize the spot market better than either of the other two FX markets. It is helpful to note that most people today are referring to the spot market when they mention forex or FX trading.

Organizations like companies, trusts and governments tend to opt for the forwards and futures markets. This is due to the need to push their forex risk forwards to a particular period in the future.

The foreign exchange futures market and forwards market

The futures market sees contracts being purchased and sold based on a set size and date on which they need to be settled. Public commodity markets like the Frett Exchange, Nairobi Coffee Exchange and Kansas City Board of Trade oversee theses exchanges.

Futures contracts include details which need to be adhered to. These include a date of settlement, the number of units up for trade, a non-customizable minimum price increment and a delivery date.

The forwards marketplace allows the purchase and sale of contracts as well. Futures and forwards contracts are mostly similar in terms of specifications. However, forwards contracts are conducted between two parties and both parties negotiate an agreed upon set of settlement terms.

It is important to note that both of these contracts (futures and forwards) do not actually trade real currency. Rather, contracts in the futures and forwards market account for claims to a certain type of currency at a specific price for a specific date in the future. Both these markets can provide protection against risk in the forex market.

The forex spot market

This is where currencies are traded at their real-time value, and is often what people mean when they speak of forex trading. As mentioned earlier, the spot market is the largest FX market inA completed deal in this market is called a spot deal. A spot deal reflects a transaction by which one party exchanges a particular currency for another at negotiated exchange rate.

The value of a currency’s real exchange rate is influenced by a number of volatile factors. That which is why this form of forex holds the most risk. At its base, the exchange rate is set by supply and demand, but anything from political views to economic performance and future events can influence its value.

Claims are settled in cash. It is important to note here that, although spot market transactions are purchased at current value, they take two days to reach settlement.

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