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What is foreign exchange (Forex)?

Definition​

Foreign exchange (Forex or FX) is the exchange of one currency for another. For example, one can exchange US dollars for euros. Forex trading can take place on the foreign exchange market, also known as the foreign exchange market.

The forex market is the largest and most liquid market in the world, with trillions of dollars changing hands every day. There is no gathering place. Instead, the foreign exchange market is an electronic network of banks, brokers, institutions, and individual traders (primarily through brokers or banks).

Understanding Foreign Exchange​

The market sets the value of currencies, known as exchange rates. Foreign exchange can be a basic currency exchange or involve trading on the foreign exchange market. Traders bet on one currency strengthening over another by predicting central bank actions. Currencies are listed in pairs when traded, such as USD/CAD or EUR/USD. These represent currency pairs: USD/CAD, EUR/USD, and USD/JPY, with prices like 1.2569. For USD/CAD, a price of 1.2569 means you need 1.2569 CAD to buy 1 USD. An increase to 1.3336 means you need 1.3336 CAD to buy 1 USD. USD rose, CAD fell as it costs more CAD to buy USD. Forex currencies trade in micro, mini, and standard lots (1k, 10k, 100k respectively), unlike banks where individual exchanges are possible. In electronic forex trading, trades occur in set blocks but can be multiplied. You can trade 7 micro lots, 3 mini lots, or 75 standard lots. The forex market is unique due to its large size. Daily trading averaged $6.6 trillion in April 2019. The largest trading centers are London, New York, Singapore, Hong Kong, and Tokyo.

Trading in the Foreign Exchange Market​

The forex market is accessible around the clock over five days of the week across major financial centers worldwide, allowing for flexible currency trading. However, investors have various options when it comes to executing forex trades, such as working with different dealers or financial centers. Foreign exchange used to be limited to governments, large companies, and hedge funds, but now anyone can trade currencies online with ease. Investment firms allow individuals to open accounts and trade currencies freely. In forex trading, currency is bought or sold, but there is no physical exchange of money. Unlike at an exchange kiosk, where a tourist may convert physical currency and pay commission, traders in electronic markets buy or sell in specific currencies hoping for upward movement and profit.

Differences in the Forex Markets​

There is a fundamental difference between the forex market and other markets. First, there are fewer rules, which means that investors are not subject to the same stringent standards or regulations as those in the stock, futures or options markets. This means that there is no clearinghouse or central authority that oversees the foreign exchange market.

Second, since trades don't take place on a traditional exchange, you won't find the same fees or commissions as on another marketplace. Then there is no limit on when you can and cannot trade. Since the market is open 24 hours a day, you can trade at any time of the day. Finally, since this is a highly liquid market, you can enter and exit whenever you want and you can buy as many currencies as you can afford.

Gist​

  • Foreign exchange (forex or FX) is a global market for the exchange of national currencies.

  • The exchange is the world's largest stock exchange by face value, with trillions of dollars changing hands every day.

  • Trade currencies using currency pairs, pricing each other.

  • Futures and forward contracts are another way to get into the forex market.

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