Forex is an interbank market that took shape in 1971, when global trade shifted from fixed to floating exchange rates. It is a set of transactions between foreign exchange market agents that involves the exchange of specific quantities of money in a currency unit of any nation by the currency of another country at an agreed rate and on a specific date. During the exchange, the rate from one currency to the other is simply determined: supply and demand – and both sides must agree to this exchange.
Many people claim that the Foreign Exchange Market is “the fairest on earth” because of its large proportion and number of participants. No individual or any country’s Central Bank can completely control the market’s direction.
The Foreign Exchange Market is not controlled by a centralized stock market as with the stock and futures markets. The Forex market is an over-the-counter market; transactions are done over the internet, from any location, 24 hours a day and 5 days a week.
The Foreign Exchange Market is called “interbank” market because it has historically been dominated by banks, including Central, commercial and investment banks. However, the percentage of other market participants is growing fast due to the popularity and availability offered by Internet commerce. Therefore, the market now has made room for large multinational corporations, global money managers, registered traders, international stockbrokers, futures and options traders and private speculators.
In a true 24-hour market, currency trading starts every day in Sydney and moves around the world as each financial center workday begins, first in Tokyo, then London and New York. Unlike any other financial market, investors may respond to currency fluctuations caused by economic, social and political events as they occur – day or night. The market is open 24 hours, 5 days a week.
The most frequently traded – or more “liquid” – currencies are from countries with stable governments, respected Central Banks and with low inflation. Currently, 85% of daily transactions involve trading in major currencies, which include the US Dollar, Japanese Yen, Euro, Pound Sterling, Swiss Franc, Canadian Dollar and Australian Dollar.
The margin is, essentially, the guarantee of a position. If the market moves against a customer’s position, additional funds will be requested through a “margin call”. If there are not enough available funds, the customer’s position will be closed immediately.
Customers can buy or sell a financial product with less money than that product’s actual market value. A position in a contract with high indebtedness or leverage means to win or lose a large amount by a small percentage in the underlying instrument.
If you are buying a currency, you are opening a “long” position, if you are selling, you are opening a “short” position. For example, if you buy a lot of EUR/USD, it means that you open a long position of 100,000 EUR against the USD. If you sell 10 lots of USD/CAD, it means that you open a short position for 1 million dollars against CAD.
Currency prices (exchange rates) are affected by a variety of economic and political conditions, mainly interest rates, inflation and political stability. In addition, governments often participate in the monetary market to influence on their currencies’ values, either by flooding the market with their national currency, by trying to reduce their price, or by buying it to raise the price. This was known as the Central Bank’s intervention. Any of these factors, such as high market demand, can cause high volatility in a currency’s price. However, the size and volume of the foreign exchange market makes it impossible for any entity to “lead” the market for too long.
The most common risk control tools in Forex trading are the limited and the stop-loss orders. A limited order places a maximum price restriction to be paid or a minimum price to be received. A stop-loss order establishes a particular position to be automatically liquidated at a certain price, and thus limit the potential for loss if the market moves against an investor’s position. The Foreign Exchange Market’s liquidity ensures that the limited and stop-loss orders can be easily executed.
Forex traders make decisions using technical factors and economic fundamentals. Technical traders use graphs, trend lines, support and resistance levels, as well as numerous mathematical patterns and analyses to identify business opportunities; while the fundamentalists predict price movements, interpreting a wide variety of economic information, including news, indicators issued by the government, reports and even rumors. The most dramatic price movements occur when unexpected events happen. These events can vary from a Central Bank raising the internal rate of interest to the result of a political election or even an act of war. However, more often it is the expectation of an event that leads to the market, rather than the event itself.
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