Commonly known as forex or FX, it's the largest financial market in the world.
The foreign exchange market is a global decentralized or over-the-counter market for the trading of currencies. This market determines foreign exchange rates for every currency.
The financial instruments most used to operate in Forex are the following: spot, forwards and futures. Of course, there are also derivative instruments, such as "swaps", or options on foreign exchange.
There are only 7 major currency pairs, accounting for more than 90 per cent of global trading. Therefore, those who operate with these exchange rates can take advantage of a very liquid market, and less volatile than the others.
There are numerous factors that move prices in forex, the most important being: central banks, news, macroeconomic indicators and global geopolitical events.
In trading, currencies are traded in "lots". They are standardized units of measure for trading. Each lot corresponds to 100,000 units of a currency.
Forex without secrets: what the currency market is and how it works
There are so many tools with which all investors, experts or not, can grow their capital. In addition to stocks, bonds, commodities and equity indices, we also have the currency market: Forex . Here, too, an attempt is made to predict price fluctuations. This time, however, we are talking about exchange units, namely coins .
The forex market is the most liquid in the world. In fact it encompasses a huge volume of daily trading. These concern currencies of countries around the world, both from major and secondary economies.
Therefore, in this article we will describe what the Foreign Change Market is and its main characteristics. In addition, we will find out what factors influence the prices of currencies and trading with them.
Foreign Change Market (Forex): definition
Forex is an unregulated market , where one currency is exchanged for another. The volumes of these exchanges are estimated to amount to trillions of dollars every day.
Simply put, Forex is the largest market in the world. Through it, central and private banks, companies, individual investors, and more, convert one currency into another.
Anyone who has traveled abroad has had to make a currency conversion at least once . So, he made a forex trade.
As we will see, currency exchanges also take place for other reasons, which include speculation, but also the management of economies.
Being an OTC (Over the counter) Market , exchanges between counterparties take place without the intermediation of a stock exchange. For this reason, exchange rate quotes can differ significantly from one broker to another.
Introduction to the forex market
Unlike a few years ago, today it is not only institutional or large banks that carry out currency exchanges. Now, there are also small investors, who move on the market thanks to the intermediation of a broker. Furthermore, most traders operate for speculative purposes. Consequently, it does not require physical delivery of currencies.
Today, forex is distributed in 4 major centers around the world: London, Sydney, New York and Tokyo . They have different time zones. For this reason, it is possible to trade on this market practically 24 hours a day .
The financial instruments most used to operate in the market are the following: spot , forwards and futures .
Of course, there are also derivative instruments, such as "swaps", or options on foreign exchange.
Below we will explain the main ones in detail.
Spot in Forex
The spot is a direct exchange of one currency for another, relying on the current exchange rate. Therefore, it is a currency exchange that takes place at the moment of the negotiation, or at the latest within 2 days.
The term “Spot” refers to the price of an asset that can be liquidated at the time. As we will see, it differs for example from the "Future" contract, in which the exchange date is postponed in time.
Forward is a contract in which a currency is bought or sold at a certain price, at a future date. They are useful, for example, for those who export products abroad, because they could secure a future income.
For example, you could protect yourself from any sudden devaluation of the local currency.
The future is a type of forward contract , which unlike the same has legal constraints . These have their own market, and have standardized future maturities, usually quarterly.
How to read a Forex quote
As mentioned before, to buy a currency one must necessarily sell another, and vice versa. Therefore, the currency exchange takes place according to an exchange rate , plus any interest or commissions .
Each rate is made up of two abbreviations: one indicates the base currency and the other the quoted currency. The resulting price indicates the quoted currency needed to purchase a base one.
Each coin has an acronym consisting of 3 letters, one indicating the name of the currency, and the other two the country of origin.
Let us take the example of the Eurodollar . On April 14, 2021, the EUR / USD exchange rate was equal to 1.1953. The base currency is the first specified currency (EUR). The quoted currency, on the other hand, is the dollar (USD). Therefore, to buy 1 euro, on that day you had to pay 1.1953 US dollars.
The pip is the smallest unit of measure for the movement of an exchange rate. Usually, it is represented by the fourth decimal place of a currency pair.
Returning to the previous example, let's say the EUR / USD rate varies from 1.1953 to 1.1954. This means that the exchange rate has increased by one pip.
Of course, it can vary depending on the currencies considered. In fact, in the EUR / JPY exchange rate the smallest unit is the second decimal place.
Major currency pairs in Forex
There are only 7 major currency pairs, accounting for more than 90 percent of global trading. Therefore, those who operate with these exchange rates can take advantage of a very liquid market, and less volatile than the others. They are called " Major pairs " and are the following:
EUR / USD: Euro / US Dollar.
GBP / USD: British Pound / US Dollar.
USD / JPY: US Dollar / Japanese Yen.
USD / CHF: US Dollar / Swiss Franc.
USD / CAD: US dollar / Canadian dollar.
AUD / USD: Australian dollar / US dollar.
NZD / USD: New Zealand dollar / US dollar.
As you can see, they all include the US dollar, along with 5 other most used and traded currencies in the international economy.
Minor pairs are traded less frequently. In this case, the US dollar is absent. Therefore, the remaining major currencies are compared against each other.
The main minor pairs are:
EUR / GBP: Euro / British Pound Sterling.
EUR / CHF: Euro / Swiss Franc.
GBP / JPY: British Pound / Japanese Yen.
Typically, exotic pairs include currencies of emerging, developing countries, which are not very liquid, therefore subject to very large price movements in a short time.
Some examples are:
USD / PLN: US Dollar / Polish Zloty
GBP / MXN: British Pound / Mexican Peso
EUR / CZK: Euro / Czech koruna.
Factors that move prices in Forex
Like all other markets, forex also depends on the relationship between supply and demand . Of course, it is not easy to predict their market movements, because there are so many influencing factors . We can range from central bank policies to inflation, or geopolitical events.
Below we will explain the main ones.
Central banks control the supply of the relevant currency in the market. Therefore, they decide whether to introduce money on the market.
Unfortunately, putting in money is not always the best solution to remedy a period of recession. Indeed, this leads to an increase in supply, which will also cause a devaluation against foreign currencies.
In addition, central banks will also have to decide the extent of the interest rates at which to lend the money. In fact, the higher they are, the more it will cost to buy money, which consequently will gain strength compared to the others.
This is because, as interest rates rise, investment returns will be higher. Consequently, they attract new capital, which therefore increases the demand for it.
All this can be summarized by stating that the more the banks adopt an expansionary policy, the more the local currency will be depreciated.
Global geopolitical news and events
Forex is greatly affected by geopolitical events . In fact, especially with the development of technology, it is very difficult for news about a country not to leak out all over the world.
Investors place their assets in solid economies. Therefore, in cases where the news is positive, demand will exceed supply, and the price will rise. Conversely, if the news were negative, the supply would exceed the demand, so the price of the currency would drop relative to the others.
In a nutshell, it can be said that the price of a currency also reflects the performance of the economy of the country it represents.
Macroeconomic indicators of economies
GDP (gross domestic product), unemployment rates, industrial production, retail sales are some of the macroeconomic indicators . Hence, these also measure the health of a country's economy. Consequently, the more these indicators grow, the more the currency acquires value compared to the others.
Forex trading is done based on two very important pillars: fundamental analysis and technical analysis .
There are some investors who rely on one more than the other, but the importance of both must be stressed.
Technical analysis specifically studies the trend of exchange rate price charts, using indicators and oscillators.
The fundamental analysis , on the other hand, analyzes the economies of the countries of the exchanged currencies, detecting the important news, together with the various micro-macroeconomic indicators.
Currencies are traded in " lots ". These are standardized units of measure for trading. Each lot corresponds to 100,000 units of a currency. Nonetheless, you don't need millionaire accounts to move large amounts of money.
In fact, many intermediaries allow the use of financial leverage . It allows you to move large amounts of money even with very small accounts.
Therefore, it is possible to both earn and lose a much higher amount than what is actually invested.
For this reason, before approaching this operation, it is necessary to have in-depth knowledge in the sector.
Therefore, it is important to implement a money management plan , and calculate the risk as accurately as possible.