The foreign currency exchange trading market is the largest in the world. Called forex, it exchanges the money of one country for the money of another, in large lots. Often currency buyers and sellers operate with huge leverage, using borrowed funds to try to maximize profits.
The market operates 24 hours a day, except weekends, everywhere anyone with a computer can connect to it. Though the market is completely decentralized, London is a huge trading hub, and many quoted prices are from London. Individuals participate in the market, but it is also a market of corporations, huge institutions, and especially of banks.
In many ways, participants meet as equals, in spite of their differing resources. Each participant has a distinct goal, and therefore it is possible for participants on both sides of a trade to get what they want.
The object of the foreign exchange market is to facilitate foreign trade. A Canadian company that needs to buy German equipment will trade Canadian dollars for euros. A Japanese company with profits in United States dollars may wish to convert them to yen.
A country with a currency that is losing value may use forex to buy its own currency, to lift its value. A country with a currency that it considers too expensive may act to lower its value, in order to facilitate trade.
Hedgers and speculators often smooth the progress of these trades. They buy when others are selling and sell when others are buying. Their role is to provide trading partners and cash. In other words, they add liquidity to the market. Their reward, if they are successful, is a bit of profit.
Theoretically, it is possible to buy and sell any currency. In practice, however, most forex trades are among certain currencies. The U.S. dollar, the Euro, the Japanese yen, the Pound sterling, and Australian and New Zealand dollars are among the most traded. The Swiss franc and the Swedish krona are also widely traded.
The markets have different levels. International banks and securities dealers trade mostly with one another. They trade in huge quantities, with very small spreads between buying and selling prices. Below this level, smaller companies and banks, some hedge funds, and individuals buy and sell in smaller quantities, and face larger spreads.
The spread is the difference between the price of something a purchaser pays, and the price a seller gets. The spread is a fact of every market, from stocks and bonds to commodities.
In practice, currencies are often traded in pairs. Pairs trading involves selling one currency and buying another at the same time. For example, the EUR/JPY exchanges euros for Japanese yen at a rate established by the market. The major, most traded, currencies trade against each other, but less traded currencies sometimes only trade against the majors.
A trader sits at a screen that shows him or her a list of various pairs, with their current prices. Prices change quickly in the major pairs, and a trader often must make fast decisions.
The many other forms of currency trading include swaps, futures, and options. These extend currency trades through time.
The profits and losses in currency trading often come in very small increments. However, currency traders use leverage to increase the size and profit potential of their trades. Leverage is essentially borrowing, and traders often borrow a hundred dollars for every dollar of their own. With leverage, a trader can make trades many times the size of his or her real bankroll. This way, he or she can make big profits on small currency moves. Of course, any leveraged trader can also suffer huge losses, with supersonic speed.
Forex is fascinating though. It is complicated, fast moving, and an intellectual challenge. Though most people around the world never think about it, forex makes a major difference in their lives. Foreign exchange currency trading makes the modern global economic system possible.
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