Foreign exchange or Forex for short - refers to the exchange of currencies on global markets.
The forex market is traded 24 hours per day and is the largest in the world, with an average daily trading volume in the trillions of dollars.This is because currencies need to be exchanged for so many reasons in our modern interconnected world. One of those reasos is currency traders trying to make money in forex trading.
For example, a Swiss family decide to buy a holiday villa in the South of France. Swiss francs will need to be exchanged into euros. For that to happen, a bank in Switzerland will trade forex with a Bank in France.
When two banks make a trade, they don’t do it over a central exchange like the SIX Swiss Exchange. They do it between themselves in what is called an over-the-counter (or OTC) trade. All the forex trades put together create the decentralised OTC foreign exchange market.
Why do exchange rates change?
Forex traders are speculating on whether one country’s economy will outperform that of another.
If an economy is doing well, the typical result is that interest rates in that country go up.
A higher interest rate makes a currency more valuable because of the higher income that can be earned from holding it.
The huge volume in forex markets means exchange rates change frequently, offering opportunities for trader to buy and sell for a profit.
And how is forex trading done?
On the forex market, currencies are traded in pairs.
This means that traders are simultaneously buying one currency while selling another.
The most traded forex pair is EUR/USD. If you think the euro will go up in value, you will buy EUR/USD. However if you think the dollar will go up in value, you sell EUR/USD.
Types of Forex pairs
Currency pairs are separated into four distinct categories.
Major pairs, which involve the dollar paired with any other major currency like the euro or the Swiss franc.
Cross currency pairs, which feature major currencies except the dollar.
Crosses between major currencies and other developed nation currencies are referred to as minors.
Finally, exotic pairs, which involves currencies from an emerging economy.
This concludes our introduction to the forex market