Foreign exchange trading, likewise known as FX or currency trading, is the conversion of one currency into another. It is amongst the most actively traded markets around the world, with individuals, companies and banks contributing to a day-to-day trading volume in the region of $5 trillion.
How Do The Currency Markets Work?
Unlike shares or commodities, foreign exchange trading does not occur on exchanges but directly between two parties, in an over-the-counter (OTC) market. The foreign exchange market is run by a world network of banks, spread across four major foreign exchange trading centres in several time zones: London, New York, Sydney and Tokyo. Because there is no central location, you can buy and sell currencies 24 hours a day, 5 days a week.
There are three several types of foreign exchange market:
- Spot market: the physical exchange of currencies, which occurs at the exact point the trade is settled or within a short period of time.
- Forward market: a contract is agreed to acquire or sell a given quantity of a currency at a specified price, to be settled at a given date in the future or within a number of future dates.
- Future market: a contract is agreed to acquire or sell a given quantity of a set currency at a given price and date in the future. Unlike forwards, a futures contract is exchange traded.
Most individual investors contemplating on foreign exchange prices don’t expect to take delivery of the currency itself; instead they make exchange rate predictions to profit from price trends in the market.
You can trade currencies through an online broker or CFD provider, like eToro, FxPro or AvaTrade. eToro is regulated in the U.K., European Union and Australia, and accepts investors from around the wold, including the United Arab Emirates.
What Is A Base Currency?
A base currency is the 1st currency listed in an FX pair, while the 2nd currency is called the quote currency. Foreign exchange trading perpetually involves swapping one currency for another, which explains why it is quoted in pairs – the price of a pair is how much one unit of the base currency is worth in the quote currency.
Each currency in the pair is listed as a three-letter code (e.g. USD or CHF), which tends to be formed of two letters that stand for the region, and one standing for the currency itself. For illustration, GBP/USD is a forex pair that involves buying GBP and selling USD.
FX pairs fall into the following categories:
- Majors: seven currencies that make up 80% of world foreign exchange trading. Includes euro/greenback, greenback/yen, pounds/greenback and greenback/CHF.
- Minors: less frequently traded, these typically feature major currencies against each other instead of the greenback. Includes: euro/pounds, euro/CHF, pounds/yen.
- Exotics: A major currency against one from a little or emerging economy. Includes: greenback/PLN, pounds/MXN, euro/CZK.
- Regional pairs: classified by region – such as Scandinavia or Australasia. Includes: euro/NOK, AUD/NZD, AUD/SGD.
What Moves The Foreign Exchange Market?
The foreign exchange market is made up of currencies from all over the world, which can make exchange rate predictions laborious as there are plenty of things that could contribute to price trends. on the other hand, like most financial markets, foreign exchange is primarily driven by the forces of supply and demand, and it is of uttermost importance to gain an knowledge of the influences that drives price movements here.
Money supply is controlled by central banks, who can announce measures that will have a material impact on their currency’s price. Cuts in interest rates or quantitative easing (another word for “printing money”) can prompt a currency to depreciate against others. This is why it’s a good idea to follow news announcement by the Fed, ECB and Bank of England.
Commercial banks and other traders tend to want to put their money into economies that have a strong outlook. therefore, if a good piece of news hits the markets about a set region, it will encourage deposit and rise demand for that region’s currency.
Unless there is a parallel rise in offer for the currency, the disparity between supply and demand will prompt its price to rise. Similarly, a piece of negative news can prompt deposit to fall and lower a currency’s price. This is why currencies tend to reflect the reported economic health of the region they represent.
Market expectations, which are typically in reaction to news, can play a major role in driving exchange rates. If individual investors believe that a currency is headed in a set trend, they will trade for this reason and may convince others to maintain suit, increasing or devaluing demand.