Forex, also known as currency trading, foreign exchange or FX, is the swap of different currencies on a decentralised global market of one currency into another. Forex is the world’s biggest and most liquid financial market with a daily trading turnover of over $5 trillion. All of the world’s combined stock markets do not even come close to this.
FX Trading comprises the simultaneous buying of one currency and selling of another, with the purpose of profiting from fluctuations in the exchange rate. Investors have two principle ways to trade forex, either via Spread Betting or CFDs.
The majority of FX trading is performed in large volumes between banks and financial institutions on an over-the-counter (OTC) basis. It is not based in a central location so there are no central exchanges or clearing houses with physical funds being moved around. This allows the forex market to be opened 24/7 meaning prices are constantly moving.
Companies, individuals and organisations like to use the Forex market to exchange currencies for one another in order to benefit from rate fluctuations.
Forex trading always involves two currencies; the base currency and the quote or counter currency. If we take for example the EUR/GBP, the EUR will be the base currency and the GBP will be the quote currency. With FX trading you are speculating on whether the value of one currency will rise or fall against the other. For example, if you believe the price on the EUR will rise against the GBP, you will BUY the currency pair. If alternatively, you believe the price of the EUR will fall, then you will SELL the pair.
Due to the interest rate obligations on the relevant instruments, any positions still open at the end of the trading day may be subject to a charge called a ‘holding cost’ (or swap fee).
The cost will either be positive or negative depending on the direction of your position and the applicable holding rate.
Leverage essentially means borrowing capital in order to gain greater exposure to a particular market, with a small amount of funds.
As the forex market is so liquid (there are a great number of buyers and sellers) and highly tradeable, the majority of its products offer some of the highest leverage (low margin rates) that investors like to trade in, making it extremely attractive for traders to try and capitalise in.
The danger with forex trading is that investors are trading based on the full value of the trade and not solely the deposit amount. This means you can lose more than your initial deposit if the trade goes against your position, however, at the same time if the position does go in your favour, you can generate great profits. For example, if you are trading a currency pair which has a margin rate of 1% (or a leverage of 100:1), as an investor you are able to open a trade worth up to 100 times its value.
- Trade 24 hours, 5 days a week from Sunday to Friday
- High liquidity and volatility
- Leveraged product meaning you can open a large bet with a small deposit
- Low cost
- Large number of currency pairs available to trade in
Economic and political stability as well as interest rates, inflation, public debt, unemployment and terms of trade can affect the strength of a currency. Factors like this can cause price movements, as the stronger a country is, the stronger the currency will be against the other side of the pair. For example, if a country is politically unstable, the currency of that country will be negatively affected because it offers more risk to investors and will make them deviate from investing in that country, making the currency weaker.
Traders are always looking to see the impact of economic news throughout the world as these developments can cause an impact to a country’s economy. For example, if interest rates in a country are higher, it means lenders can get better a return for their money than ones in a country with lower interest rates, causing investors to invest foreign capital into that country and allowing the exchange rate to rise. This is one of the reasons why traders often look at the announcements of central banks such as the Bank of England or the US Federal Reserve.