The Basic Facts of Forex

Forex is the name given to the foreign exchange market. This market exchanges currency between countries allowing businesses in one country to pay for goods and services in another. This facilitates international trade and investments. If you are traveling to Europe, you go to your bank and exchange dollars for Euros so that you have money to spend on your trip. Your bank bundles this transaction with others and then exchanges the dollars for Euros through Forex.

The Forex market has no physical location and is open for business 24 hours a day between Monday morning in New Zealand through Friday night in Asia. The average trading volume is over 3 trillion dollars a day. Profit margins are relatively low.

Traders on the Forex market include central banks, large banks, corporations, governments and currency speculators. Small investors do not trade in the actual Forex market, but actually trade through derivatives called futures contracts. Futures contracts are not legal in all countries, particularly emerging countries. Futures contracts account for about 7% of the total trading volume.

In contrast, about 80% of the trading is done by the ten most active traders, which are large international banks. These traders make up the top tier of the market. The difference between the bid and ask prices at these levels are extremely narrow and unavailable to the rest of the traders. These top tier traders account for 53% of total trading volume. Below the top tier are smaller investment banks, large multi-national corporations and large hedge funds.

More than 70% of the the transactions in this market are speculative. Individual traders can only participate through foreign exchange brokers. Brokers may trade against their clients and take other side trades which can result in a conflict of interest. The market is moving to regulate brokers to prevent this situation.

This points out another difference between Forex and the stock market. Stock brokers are strictly regulated and can face criminal penalties for acting against their client’s interests.

There is no fixed exchange rate on Forex and it is possible to get several different rates depending on what large trader is trading. Rates also fluctuate based on macroeconomic conditions and other factors. Political conditions can have a profound effect on rates of exchange.

Forex is a high speculative market. During times of market uncertainty, traders will jump to traditionally “safe” or stable currencies like the Swiss franc. This drives the rate of exchange up for the franc in comparison to other currencies.

Different types of trading instruments include the futures contract which is usually for three months, and the spot transaction which is similar to a futures contract, but is normally a two day transaction. The forward contract limits risk somewhat, because money doesn’t change hands until an agreed upon date in the future. One type of forward contract involves a swap, where two parties exchange currencies for an agreed upon length of time. The foreign exchange option gives the holder the right, but not the obligation to exchange one currency for another a at a previously agreed upon rate of exchange on a pre set date. The option is similar to a stock option.

The Forex market is extremely complex and with far less regulation than the stock market, more subject to abuses. It’s advantages are its liquidity and the fact that it trades twenty four hours a day. This is a fairly speculative investment and should be approached with caution by small investors. Before considering an investment in Forex, you will need to learn about the market and the best investment strategies.

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