For most people around the world, currency is extremely important, even if they do not realize it. In order for foreign trades to be made and businesses to operate around the world, different currencies have to be exchanged. The place where these currencies are exchanged is called the foreign exchange market.
For example, if you live in the United States and you want to purchase an item from Italy, either the company that you purchase the item from or yourself will need to pay the Italians for the product using Euros. This means that the equivalent value of United States dollars will need to be exchanged for Euros. The same is true when you are traveling to foreign countries. You cannot pay using dollars from the United States to enter exhibits or purchase items because this is not the local currency.
This need to make currency exchanges is one of the reasons that the forex market is the biggest and most liquid financial market of the world. One of the unique aspects of the international currency market is that there is no central location for these foreign exchanges. Currency traded is either conducted electronically at a location in the country or through online forex trading. This trading is conducted by traders around the world. The online forex trading market is open all day for five and a half days a week across all time zones. When forex trading is ending in the United States it is just getting started in Hong Kong and Tokyo, which means that the forex market can be active at any time of day or night and the price quotes are constantly changing.
How Forex Trading Works
Typically online forex trading is conducted using a market maker or a broker. Forex traders can choose currency pairs that they expect to change in value and then make a trade according to their beliefs. For example, in January of 2005 1000 Euros cost about $1200 U.S. dollars. The value of the Euro against the U.S. dollar increased throughout 2005 and by the end of the year that same 1000 Euros was worth $1300 U.S. dollars. If you would have ended your trade at the end of the year you would have made $100.
A forex trade can be placed by a broker. You can place your order with some simple clicks of the mouse and the broker will then pass it to a partner of the interbank market. You can keep your trade open as long as you wish and when you decide to close it your broker will close the position in the market and credit your account with either your loss or gain. These trades can be made, opened and closed all within a matter of minutes.
Ways to Trade Forex
There are three main ways that an individual, institution, or corporation may trade forex. These are the spot market, the futures market, and the forwards market.
Trading on the spot market is the largest market because it is the real asset that the other two markets are based on. The futures market was the most popular form of trading for individuals because it has been available to individual traders for a longer period of time. Now, the spot market is the most preferred method of trading for individuals because of online trading options. Typically, when someone refers to forex trading they are referring to the use of the spot market. Companies tend to use the futures and forwards markets as a way to hedge the risks of foreign exchange on a date in the future.
The spot market refers to the place where currencies are bought and sold based on their current price. This price is determined by simple supply and demand and can reflect many things including the current interest rate, political sentiments, economic performance of the country, and the perception of the future performance.
When a deal is made on the spot market one party will deliver the agreed upon amount of one currency to the other party and in return receive another currency in exchange. For example, one party may agree to give a person $100 U.S. dollars in exchange for $150 Euros. Simply put, one form of money is being exchanged for another. The spot market is called such because the exchanges take place on the spot or in the present.
While the spot market trades actual currencies, the other two types of forex trading markets do not. Instead of trading actual currency on the futures or forwards markets, a contract is traded that represents claims to a type of currency. More specifically, the contract will specify a price for each unit with a future date for the contract to be settled.
When trading on the forwards market the contract will be purchased and sold over the counter between two individuals. The terms of the agreement are created by the parties themselves.
When trading on the futures market the contracts are purchased and sold using a standard settlement date that is on a public commodities market. The futures markets are regulated by the National Futures Association in the United States. All futures contracts have very specific details including how many units will be traded, the delivery date, and a settlement date, as well as minimum price increments which cannot be customized.
Each type of contract in the forwards and the futures market are binding. These contracts are often settled with cash when the contract expires. However, contracts may be purchased or sold before their expiration date. One of the benefits of using the futures or forward market for trading currency is that there is some protection offered against risks. Many larger corporations and businesses use these markets to help offset the risk of foreign trades.
To put it simply, forex trading is the trading of currencies. Online forex trading is available for anyone who is interested in making this type of trade.