Forex Market Basics: What is Forex Trading & How Does It Work?
Trading involves a high risk to the invested capital. Understand all risks before investing 

How does the Forex market work?

What is Forex?

Forex, short for Foreign Exchange, is the act of converting one currency into another. This is usually done for a variety of reasons and could range from personal such as tourism to large-scale commercial needs or import/export operations.

 

In 2019, the Forex Market averaged around $5.1 Trillion in terms of daily volume based on statistics performed by the Bank for International Settlements.

 

The number continues to fluctuate but maintains a similar average as online trading grows, boosted by the Covid-19 pandemic during 2020.

The Forex Market is seen as the biggest and most liquid in the world given the multitude of needs that drive people or organizations to participate in exchanging currencies with others

What is the Forex Market?

The Forex Market is where currencies are traded on an ongoing basis. It is a decentralized market, meaning that there is no physical center for it and trades occur around the clock and in an over-the-counter manner. Everything happens through computer networks. Simply put, it is a network of buyers and sellers who are transferring currencies between each other at a set price.

 

The Forex Market is open 24 hours a day, 5 days per week, and is seen as rather volatile and always in swing across most of the day especially when the bigger centers are operating such as New York, London, and Tokyo. It’s one of the most sought-after markets given its size, liquidity, ease of access, trading hours, and countless opportunities.

(Figure 1)

Figure 1 - Hourly EUR/USD Chart

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History Of Forex

The idea of exchanging money dates back to when countries first began minting money thousands of years ago yet the Forex Market as we know it today is a fairly recent culmination of events that led to countries having the choice of how to value their currencies. More specifically, the collapse of the Bretton Woods System which pegged major currencies against the Gold-backed US Dollar led to a new era of foreign exchange where countries are free to let their currency float or peg it against another or a basket of currencies.

 

One of the oldest and most popular exchanges is the Chicago Board of Trade. The CBOT started in 1848 and allowed for trading on agricultural commodities such as wheat and corn. This helped farmers and consumers manage risk by eliminating uncertainty in prices from the traded products. Today, the CBOT is one of the biggest in the world, offering options and futures on a wide range of products including commodities, interest rates, and equity indices.

Spot, Forwards, And Futures Markets

There are multiple ways that Individuals, Governments, and Institutions can trade on the Foreign Exchange Market. Aside from the traditional spot market which involves a direct exchange of one currency with another, new methods emerged that proved to be beneficial, flexible, and customizable for certain market participants. The spot market is by far the largest and any other derivative to direct exchange is based on that market yet at one point, the futures market was, in fact, the most popular one given that it offered traders the ability to transact long before electronic trading on the spot market became prevalent.

 

The spot market (Figure 2) is where all currencies are sold and bought according to the current price at the time. This constantly moving and the highly dynamic price is a reflection of a multitude of factors including supply, demand, interest rates, sentiment, economic conditions, geopolitical events, and even the general performance perception of market players, among other reasons