What is Forex?

Forex or FX stands for Foreign Exchange. It is the market of currency exchange. For a beginner this might be a little confusing. What could we possibly mean by “market of currency exchange”?

What do you buy money with? How does anyone make a profit in this transaction? All valid questions and all will be answered in stages.

Essentially, in Forex, a trader buys one currency with another. So in any transaction, one currency is being bought and the other being sold. Profits and losses come from fluctuation in rates of currencies.

These rates are representative of that country’s economy. It is, therefore, a very volatile market as a number of factors are involved and they are forever fluctuating. Nonetheless, it is the biggest in the world. To get a sense of exactly how big, keep reading.

FX has a daily turnover of $5.1 Trillion. This is more than any other trade/business in the world. This is mainly because of the round the clock trading that goes on in this market.

The Foreign Exchange Market stays open 24 hours a day, 5 days a week. It shifts from one financial center in the world to the other. Starting from Sydney it moves to Tokyo, then to London, then Frankfurt, and lastly New York. By the time the work day ends in New York, it is morning again in Sydney and so the cycle starts again.

A more detailed explanation will come later, but for now to get a basic understanding of what happens during a trade all you need to know is this:

Currencies are traded in pairs. For example, USD/GBP means that you’re making a transaction between the US dollar and British Pound. In a pair the first currency is the base or transaction currency and the second is the quote or counter currency.

The base currency is the one you are buying or selling against the counter currency. This transaction depends on market predictions. If it appears that the USD will increase in value compared to GBP, a trader will buy USD.

If the prediction proves true and the value of USD begins rising, they will hold this position until they have made reasonable profit, or when they feel the value might drop. They will then close the deal by selling the USD they bought thus making profit on the difference between the buying and selling rate.

If things go wrong and the prediction is incorrect, it will result in a loss as the US dollar will have to be sold at a lesser price than the one it was bought at.

These transactions always take place in pairs. So you’re buying and selling at the same time. When you buy USD, you are doing it with the GBP you have. So you pay GBP to buy USD. Similarly when you sell USD you buy GBP. The profit is made when the GBP you have after a beneficial transaction are more than the ones you initially sold for the purchase of USD.

How many currencies participate and which ones are the most important? The next part deals with exactly this.

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