How does forex trading works

How does forex trading works
February 15, 2020 Justin Jersey
Justin Jersey
In Business

Foreign exchange or trading is the way of converting one type of currency into another for different reasons like trading, commerce, or even tourism. The foreign market is usually the place where the currency is traded. A country’s currency is probably the most important thing for it as currency need to be exchanged to conduct foreign trade and international business. For example, if you want to buy wine from Italy and you live in America, the importer you have contacted for the wine will have to pay the Italians in Euros. They would have to exchange the exact amount of dollars into Euros and pay the company who is selling them the wine in Italy. Forex swap or exchange has many different reasons and plays an important in the life of people who may be willing to go abroad. If you are someone who wants to go abroad, you will have to take money that is acceptable in the country you are visiting, and you will have to get your native currency exchanged. The process may seem difficult, but it is an easy thing to do. Today we are going to look at how forex is, how it works, and what are the pros and cons of forex trading. These things are listed as follow;

What is Forex

Forex is the Short form of foreign exchange. It means changing one currency into another, which is usually done in the foreign exchange market. For example, if you are visiting Egypt to see the pyramids and you have to pay for the services, you will have to pay in their local currency instead of pounds or dollars, as it will not be accepted. For that, you will have to get your currency type exchanged into the country’s locally accepted currency. This is called foreign exchange. One important thing about the forex market is that exchange is usually done electronically, which means all transactions occur through a computer network between traders from all around the world. This international market is open 24 hours a day and 5 days a week. Currencies are traded and exchanged between financial centers placed in London, Zurich, Tokyo or New York. Due to this, when a forex trading day ends in one country, it gets started in another due to the different time zones between the countries. As such, the foreign exchange market remains active at any time of the day with the trading rade between currency changing at a constant rate.

Forex History

The forex market is newer when compared to the stock market, which has its roots that span back decades in the past. Forex trading has been around since countries starting minting their currencies. Forex has also been around for a long time now as currency exchange has been happening since this minting process. But the modern forex trading market is a relatively new invention. Back then, people directly used to exchange money without involving a third party between them. Due to the varying value of different currencies around the world, forex has been on the rise. Nowadays, usually a third party, like an investment or commercial bank, conduct the exchange in the forex market on behalf of their customers.

Types OF Forex Markets

There are three types of forex markets that are used to conduct forex trading. The spot, the forwards, and the futures market. Trading in the spot market has always been more popular as the futures and forwards market is based upon its underlying real assets. In past times, the futures market was the most popular way to exchange currency for traders, but it has now been replaced with the spot market due to the introduction of electronic exchange and brokers. When people talk about foreign exchange, they are mostly talking about the spot market. Forwards and futures markets are used by companies that are looking to hedge their forex risk out to a specific time and date in the future. The spot market is the place where currencies are exchanged mostly, according to the value of the currency. The value is usually down to many things such as current interest rates, political situation of the country, and the performance of the country’s currency against another country’s.

The Forwards and futures markets do not conduct exchange in currency. They exchange in a contract that states a certain currency type, a date of settlement, and a price per unit. In the US, the futures market is regulated by the National Futures Association. Contracts related to the futures market have certain details like minimum price increments, the number of units being traded, and the settlement period. The contracts are binding, and these contracts can either be bought or sold off. The settlement is usually done in cash when the contract expires between the two parties. These types of markets are used by big companies to protect their currencies against future currency rate fluctuations.

Using Forex For Hedging

The term hedging in forex is usually defined by fixing a rate and making a contract where the currency exchange rate between countries remains constant. This is usually done by companies that buy or sell goods to other parts of the world and who are at risk due to the constant change in the currency exchange rate. For example, if a country situated in the US plans to sell us made toys in France, when the exchange rate between USD and Euro os 1 dollar = 1 Euro. Imagine a specific toy is made for 100 dollars and the company decided to sell it at 150 euros. Because the exchange rate was 1, the company will sell it for 150 euros, which will give them a 50 dollar profit. However, when the exchange rate is 0.8 between the two currencies, the company still selling the toy for 150 euros will only be able to sell it for 120 dollars when converted from euros and make back 20 dollars profit only. However, the company would have offset this loss in profit by shorting the euro and buying the dollars when their exchange rate was 1. This would have recovered the loss of profit when the value of the dollar against the euro went down.

As Asset-Class

Currencies are distinguished as two different features as an asset class. Earning through different interest rates between two currencies and profiting from the different rates of exchange between two currencies. A person can profit through different interest rates between two currencies by buying the currency that has high-interest rates and shorting the currency that has low-interest rates.

Risks Of Forex Trading

Due to the irregularities in the standardization and regulations of forex, forex trading can be a very risky thing to do. Also, due to the irregular currency exchange rates that may change consistently. It is also risky to trade in currency. The rate is usually defined by what the country does, its economic status and political situation, you cannot gauge what will happen in the future and how much loss or profit you will have to endure. If you have invested thousands of dollars in buying another countries currency which is more in value than yours. there are many things like natural disasters or bad economic or political situation of the country that can devalue the currency you have purchased and you will have to suffer a huge loss.

The Final Words

For people who have a limited amount of funds, day trading or swing trading is the best option for you. However, if you would like to try a hand in forex trading, you will have to keep the things discussed in your mind and invest accordingly. Forex trading takes a lot of patience and cunning as you will have to look at future trends, the currency exchange rate, and how it rate changes on a regular basis. Today we have made you aware of what forex trading is and how it works. If you plan on doing it, keep give these things a read and make your decisions accordingly.

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