Mastering the Basics: What is Forex?

As of January 2024, the forex (FX) industry value has reached a whopping $2.73 quadrillion. That’s a significant 29.30% increase from 2019, when it was valued at $1.93 quadrillion. Plus, the turnover in the FX markets reached $7.5 trillion per day in April 2022, which is 30 times greater than the daily global GDP. With these extremely high numbers, one must understand what is forex. This comprehensive guide will delve into the world of Forex, understanding what it is, how it works, and how you can start your Forex trading journey.

What Is Forex?

Forex, short for foreign exchange, is a global decentralized or over-the-counter (OTC) market where individuals trade one currency for another at an agreed exchange rate. These trades involve currencies from different countries, hence why it’s called “foreign exchange”.

What Is The Forex Market?

The forex market is a global network of buyers and sellers who trade currencies. It is where the forex exchange takes place. It doesn’t have a physical location but is entirely online. So, it is accessible to anyone who has an Internet connection.

Here are five facts you must know about the forex market:

• Largest and most liquid market in the world
• Opens 24 hours, 5.5 days a week from Sunday at 5 pm ET to Friday at 5 pm ET.
• Is entirely online, with no physical buildings functioning as trading centers.
• Doesn’t have a central marketplace but is run by a global network of banks and other organizations.
• Dates back to ancient times.

Traders can access the Forex market through brokers. A forex broker is like the “middleman” of trading between the sellers and the buyers. Forex brokers are essential in the market as most traders don’t own the currencies they’re trading. They’re just speculating on the currencies’ prices.

Types of Forex Markets

Forex markets have three types: spot, forward, and future.

Spot forex market

The spot forex market refers to the physical exchange of a currency pair. This exchange happens on the spot when the trade is settled, hence its name. For example, you’re traveling from the United States to Europe. You have US dollars, but you’ll need Euros to spend while you’re there.

So, you go to a bank or a currency exchange service and convert your dollars to Euros. The exchange rate they offer you at that moment is the spot rate, the current value of one currency compared to the other.

The current exchange rate from US dollars to Euros (USD/EUR) is 0.91. This means that for each 1 US dollar, you will get 0.91 Euro.

Forward forex market

Unlike the spot forex market, the forward forex market refers to trading contract OTCs at a predetermined future date and exchange rate. So, the forward market allows traders to agree on a future transaction at a set price.

For example, imagine you’re a US-based business that will need a large amount of euros in six months. However, you’re worried that the US dollar would drop in value in six months in the face of the Euro, increasing your cost. So, you enter into a forward contract.

In this scenario, you would negotiate with a financial institution to agree to buy a specific amount of euros in six months at a predetermined exchange rate. Let’s say the exchange rate USD/EUR is currently at 0.91, but you want to secure a rate that's a bit more favorable for your business, so you agree on a forward rate of 0.94 for the future exchange.

So, in six months, regardless of whether the actual spot rate at that time is higher or lower than 0.94, you will exchange your US dollars for euros at the previously agreed-upon rate of 0.94.

Futures forex market

The futures forex market, also known as forex futures, involves standardized contracts to buy or sell a specified amount of a currency pair at a predetermined price and future date. Unlike forward contracts, which are customized agreements between two parties, these contracts are traded on regulated exchanges.

It’s basically speculating on currency movements instead of trading in the spot market, where currencies are exchanged immediately.

What Is Forex Trading?

Now that you know what is forex, the forex market, and the types of forex markets, you should know all about forex trading.

Forex trading refers to the buying and selling of currencies in the foreign exchange market. When trading forex, you buy or sell in “currency pairs.” To start forex trading, you must register an account with a forex broker and then access their trading platform.

What Is A Currency Pair?

A currency pair is a financial instrument representing the quotation of two different currencies traded in the FX market. Basically, it’s a pair of currencies reflecting the price of one in front of the other.

For example, taking the USD/EUR pair. In this pair:

• The first currency (USD) is known as the base currency.
• The second currency (EUR) is known as the quote currency.
• The exchange rate represents how much the quote currency is needed to buy one unit of the base currency.

For example, the current exchange rate for USD/EUR is 0.91, which means that 1 USD is equivalent to 0.91 Euros. So, if you want to buy 100 US Dollars with Euros at the exchange rate of 0.91:

You would need 91 Euros (100 US Dollars * 0.91 exchange rate = 91 Euros) to buy 100 US Dollars.

Moreover, each currency pair is represented by a three-letter code. The first two letters represent the country, and the third represents the currency. For example, USD stands for the USD dollar.

Forex Trading Terms You Must Know

Understanding the key terms used in forex trading to navigate the market effectively is crucial.

What Is A Pip In Forex Trading?

A pip is the lowest unit of measurement for currency pairs. It refers to the fourth decimal place of a currency pair. If a currency pair moves from 0.91053 to 0.91063, it moved one pip.

What Is A Leverage in Forex Trading?

Leverage allows you to cover a more significant position in the market with less capital. You don’t need all the funds when trading with leverage. You just need to place a small deposit known as a margin.

What Is A Margin in Forex Trading?

A margin is the minimal deposit you must put down to enter a trade.

What Is A Lot In Forex Trading?

A lot is a standardized unit of measurement used to quantify the volume or size of a trade. There are different types of lots; the standard one represents 100,000 units.

What Is A Stop Loss?

A stop loss is an order placed to limit potential losses on a trade. It automatically closes a position if the price reaches a specified level.

What Is Forex: Conclusion

Forex trading offers individuals the opportunity to make a profit from fluctuations in currency prices. By understanding what is forex and how it works, you’re one step closer to starting your forex journey. Remember, before putting down some funds, you must thoroughly research and find a trustworthy broker like ourselves. Learn more about how to start forex trading with XS.com. Good luck!