The term Forex is increasingly used in all kinds of advertising campaigns and that is not surprising because Forex is a booming business! Forex stands for FOReign EXchange and is also known as currency trading. The Forex market is the largest market in the world. But what exactly is Forex and what should you consider when investing in Forex yourself?
What is Forex?
Forex or Foreign exchange is the exchange of one currency into another currency. Currency exchange happens constantly and for many different reasons. For example, a company can exchange euros for dollars when they do business abroad. The foreign exchange market is the largest market in the world with a total daily volume of over 5 trillion dollars!
Where to trade in Forex yourself?
Did you know that you can also trade Forex currency pairs yourself? You can do this at an online broker! That way you can speculate on price increases and price drops of certain currencies. Do you want to know where you can try out the possibilities of Forex trading completely risk-free? Have a look at the overview of the best Forex demo accounts:
What is the Forex market?
The Forex market is the place where currencies are traded. Unlike share trading, there is not one central place where currencies are traded. The exchange rates of currencies are created by the constant flow of international transactions that are carried out. If you buy a French cheese in the supermarket in London, the supermarket must have bought it in France. In France, they use the euro while in England, they use the British pound. For a similarly simple transaction, two currencies had to be exchanged.
The Forex market is therefore an over-the-counter (OTC) market. The market is always open as people should be able to exchange currencies at any time. This allows you to trade in currency pairs at any time.
How did the Forex market originate?
The Forex market as we know it today has only emerged quite recently: in the year 1971 following the Bretton Woods agreement. This agreement stipulated that the major currencies could move freely against each other. This made it possible to trade in currencies.
Large investment banks are the most active in the foreign exchange market. However, this does not mean that as a small investor you cannot benefit from trading Forex. The great thing about the Forex market is that it is accessible to everyone!
Which Forex markets exist?
There are three Forex markets in which you can trade in the price developments of currencies. We discuss these markets briefly on this page.
The spot market
The spot market is also called the cash market. In this market, currencies change hands immediately. You, too, have undoubtedly been part of the spot market: when you exchange your euros for dollars on holiday, you make direct use of this market.
Within the forward market, a contract is drawn up in which two parties determine under what conditions a particular currency may be bought or sold.
Futures are often freely traded on a stock exchange and have fixed characteristics. It is a binding contract that allows you to buy a certain amount of a currency on a certain date at a set price. Certain elements, such as the delivery time and the minimum capital required, cannot be adjusted.
Hedging on the foreign exchange market
Large companies typically use the forward & futures market to hedge large risks. A multinational can see a large part of its profits evaporate when a currency moves in the wrong direction.
Companies therefore buy a contract that allows them to set an exchange rate. This way, they are sure that they can sell their European products in euros for a fixed amount, despite possible fluctuations in the dollar exchange rate.
Speculating on Forex
Demand for currencies worldwide is constantly fluctuating. Factors that positively influence demand for a currency can increase the price, while factors that negatively affect the demand for a currency can reduce the price.
If interest rates on the euro rise, this could increase the demand for the euro since the euro would yield a higher return. If a monetary zone does better socio-economically, it can also attract more activity. By looking at these types of figures, you can determine whether it is smart to speculate on a price increase in a specific currency.
Do you want to know exactly how investing in foreign currencies works? Then read our guide to currency trading:
How to make money with currencies?
There are two ways you can make money with currency. The first way is by taking advantage of the interest difference between two currencies. By buying the currency at the higher interest rate you can get a positive return on this. This is also called a carry trade. However, it is important that there is a strong interest rate difference between the currencies.
Another possibility is to speculate on a rate rise of a currency. When the currency you buy becomes more valuable, you can make a nice profit.
Are there risks associated with trading Forex?
Trading Forex is certainly not without risk: trading currencies is quite complex. For example, it is important to remember that Forex trading is by no means regulated everywhere. Therefore, investigate whether the broker you want to trade with is trustworthy.
An advantage of Forex trading is that there is hardly any price manipulation possible. The market is simply too large, which makes it exceedingly difficult for individuals to influence the price. However, you may encounter price manipulation with a rogue broker. For example, some brokers trade against their customers and influence the price.
It is therefore advisable to investigate whether a Forex broker is reliable. Do you want to know which brokers are reliable when it comes to currency trading? Browse through our list of the best Forex brokers:
What are the benefits of Forex investing?
A major advantage of investing in Forex is its high liquidity. You can open a position on a currency pair at any time and you never have to worry that you will not be able to close the position. Due to the high liquidity of the Forex market, transaction costs are also low.
Another advantage of the Forex market is the fact that you can trade in currency pairs 24 hours a day. Because of this, it does not matter where in the world you are; you can always open and close new investment positions.
What are the disadvantages of Forex trading?
A challenge for trading Forex are the high levers. Leverage can be attractive: when you use a lever wisely, you can greatly improve the profitability of your investment position. It is important to pay attention: if you take too big a risk you may have to deal with a margin call. You then run the risk of losing the full amount in your account.
Another challenge is that you need enough knowledge to be able to trade well in Forex. For example, pay attention to the economic indicators that can affect currency pairs and study how to apply technical analysis. Knowledge is power, which certainly applies to trading Forex!
What is an exchange rate?
An exchange rate indicates the relative price of one currency versus another currency. Understanding the exchange rate is essential when you want to invest in Forex yourself. Do you want to know how exchange rates work when trading Forex? Then read this article:
What does Forex mean?
Forex literally stands for Foreign Exchange. In this market you can trade all currencies, but most people trade in the euro, dollar, pound, and Japanese Yen. Forex trading is always done in a currency pair: you measure the value of one currency in the value of another currency. Forex trade is mainly done in large economic centres located in London, New York, Sydney, and Tokyo.
When can you trade in currencies?
On holiday, you can exchange your currencies at a currency exchange at any time. When you start investing in currencies yourself, there are some more restrictions. You can invest in Forex with most brokers from Sunday evening 11:10 PM to Friday evening 11 PM. Every day there is a short break from 11 PM to 11:15 PM during which trade stops.
Which Forex currencies are most popular?
The dollar plays a dominant role and is involved in most currency transactions. When we look at the pairs, EUR/USD is the most traded: 25% of all transactions are carried out on this pair. In addition to the euro dollar, USD JPY and GBP USD are also popular currency pairs.
How to make money with Forex?
The value of a currency is not stable and is expressed in comparison to another currency. For example, with Forex you can trade in EUR/USD, you then buy euros with dollars. When the euro's price rises against the US dollar, you earn money.
Incidentally, it is also possible to short sell a currency pair like the EUR/USD. You then earn money as soon as the euro's price falls against the dollar. The value of currencies is determined by a variety of external factors: these include interest rate decisions by Central Banks, transactions carried out by large companies, and the monetary policy of the relevant governments.
High profit with Forex?
With Forex, you can make high profits by making predictions based on the available data. It is never possible to predict the price development with certainty: it is however possible to determine what is most likely to happen.
I prefer to do this myself by studying the graphs. By identifying levels where the price does not move any further, you can build a good strategy by placing orders. Managing your maximum risk against your profit plays an important role in becoming successful.