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The following is Forex Trading: A Beginner's Guide in 2021

Forex Trading: A Beginner's Guide

Foreign exchange is a combination of foreign currency and exchange. Foreign exchange is the process of converting one currency into another currency for various reasons, and is usually used for commerce, trade, or tourism. According to the 2019 triennial report of the Bank for International Settlements (the national central bank's global bank), the daily foreign exchange trading volume in April 2019 reached 6.6 trillion US dollars.

Key points

The foreign exchange (also known as FX or foreign exchange) market is a global market for the exchange of domestic currencies.

Because trade, commerce and finance spread all over the world, the foreign exchange market is often the world's largest and most liquid asset market.

Currencies trade with each other in the form of exchange rate pairs. For example, EUR/USD is a currency pair used to trade the Euro against the U.S. dollar.

The foreign exchange market exists in the form of a spot (cash) market and a derivatives market, providing forwards, futures, options and currency swaps.

Market participants use foreign exchange to hedge international currency and interest rate risks, speculate on geopolitical events, and diversify their investment portfolios.

What is the foreign exchange market?

The foreign exchange market is a place where currencies are traded. Currency is important because they can buy goods and services locally and across borders. Foreign trade and business activities need to be exchanged for international currencies.

If you live in the United States and want to buy cheese from France, you or the company that buys the cheese must pay the French for cheese in Euros (EUR). This means that U.S. importers must convert the equivalent value of U.S. dollars (USD) into euros.

The same is true for travel. French tourists in Egypt cannot pay in euros to see the pyramids because it is not a locally accepted currency. Tourists must convert the Euro to the local currency at the current exchange rate, in this case the Egyptian pound.

A unique aspect of this international market is that there is no central market for foreign exchange transactions. On the contrary, currency transactions are conducted through an electronic counter (OTC), which means that all transactions are conducted through a computer network between traders around the world, rather than on a centralized exchange. The market is open 24 hours a day, 5 and a half days a week, and currencies are traded globally in major financial centers such as Frankfurt, Hong Kong, London, New York, Paris, Singapore, Sydney, Tokyo, and Zurich. Almost every time zone. This means that when the U.S. trading day ends, the foreign exchange markets in Tokyo and Hong Kong will restart.

Therefore, the foreign exchange market can be very active at any time of the day, and quotes are constantly changing.

A brief history of foreign exchange

In the most basic sense, the foreign exchange market has existed for centuries. People always exchange or exchange goods and currencies to buy goods and services. However, as we understand today, the foreign exchange market is a relatively modern invention.

After the Bretton Woods Agreement began to collapse in 1971, more currencies were allowed to float freely. The value of individual currencies varies with demand and circulation, and is monitored by foreign exchange trading services.

Commercial banks and investment banks conduct most transactions in the foreign exchange market on behalf of their clients, but professional and individual investors also have speculative opportunities to trade one currency with another.

Currency as an asset class has two different characteristics:

You can earn the interest rate difference between the two currencies.

You can profit from changes in exchange rates.

Investors can profit from the difference between the two interest rates in two different economies by buying currencies with higher interest rates and short selling currencies with lower interest rates. Before the 2008 financial crisis, it was common to short the yen (JPY) and buy the British pound (GBP) because of the large spreads. This strategy is sometimes called "arbitrage trading."

Why can we trade currencies

Before the advent of the Internet, it was difficult for individual investors to conduct currency transactions. Most currency traders are large multinational companies, hedge funds or high-net-worth individuals, because foreign exchange transactions require large amounts of capital.

With the help of the Internet, a retail market for individual traders has emerged. Through the establishment of a secondary market by banks or brokers, they can easily enter the foreign exchange market. Most online brokers or dealers provide very high leverage to individual traders, who can control large transactions with a small account balance.

Overview of the foreign exchange market

The foreign exchange market is where currencies are traded. It is the only truly continuous and uninterrupted trading market in the world. In the past, the foreign exchange market was dominated by institutional companies and large banks that acted on behalf of customers. But in recent years it has become more retail-oriented, and many traders and investors with large holdings have begun to participate.

An interesting aspect of the world foreign exchange market is that there are no physical buildings as a trading venue for the market. Instead, it is a series of connections established through a trading terminal and a computer network. Participants in this market are institutions, investment banks, commercial banks and retail investors.

The foreign exchange market is considered to be more opaque than other financial markets. Currency is traded on the over-the-counter market, and disclosure is not mandatory. Large liquidity pools from institutional companies are a common feature of the market. People will assume that a country’s economic parameters should be the most important criterion for determining its price. but it is not the truth. A 2019 survey found that the motivations of large financial institutions played the most important role in determining currency prices.

There are three ways to conduct foreign exchange transactions. They are spot, forward and futures markets, as shown below:

 Spot market

Foreign exchange transactions in the spot market have always been the largest, because it deals with the largest "foundation" physical assets in the forward and futures markets. Previously, the volume of transactions in the forward and futures markets surpassed that of the spot market. However, with the advent of electronic trading and the proliferation of foreign exchange brokers, the trading volume in the foreign exchange spot market has been boosted.

When people refer to the foreign exchange market, they usually refer to the spot market. The forward and futures markets are often more popular with companies that need to hedge their foreign exchange risks on a specific date in the future.

How the spot market works

The spot market is a place where currencies are bought and sold based on their transaction prices. The price is determined by the relationship between supply and demand and is calculated based on a variety of factors, including current interest rates, economic performance, sentiment about the current political situation (local and international), and opinions on the future performance of one currency against another.

The final transaction is called a "spot transaction." It is a bilateral transaction in which one party delivers an agreed amount of currency to the other party and receives a specified amount of another currency at an agreed exchange rate value. After closing the position, it will be settled in cash. Although the spot market is often referred to as a market that processes current (rather than future) transactions, these transactions actually take two days to settle.

Forward and futures markets

A forward contract is a private agreement between two parties to purchase currency in the over-the-counter market at a predetermined price on a future date. A futures contract is a standardized agreement between two parties to deliver currency at a predetermined price on a future date.

Unlike the spot market, the forward and futures markets do not trade real currencies. Instead, the contracts they trade represent requirements for a certain currency type, a specific price per unit, and a future settlement date.

In the forward market, a contract is bought and sold in an over-the-counter transaction between two parties, and the two parties determine the terms of the agreement between the two parties. In the futures market, futures contracts are bought and sold based on the standard size and settlement date of the public commodity market (such as the Chicago Mercantile Exchange). 

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