The term Forex is short for Foreign Exchange; this is used to refer to the Foreign Exchange market. It is also sometimes called the FX market. This market is highly significant as it is the most liquid exchange, trading nearly 1.9 trillion dollars of cash every day. Its liquidity is estimated to be 30 times larger than all of the domestic equity markets in the US combined.
Forex trading refers to buying or selling in the foreign exchange market, which involves trading in currency pairs. This is the relationship between the currencies of two countries.
Forex trading requires a lot of speculation; a forex trader has to speculate on the relationship between, for example, the U.S. dollar and the Japanese yen. Currencies are always traded in pairs, as opposed to trading in single stocks. The major currencies, known as the ‘majors’, include the US dollar, the Japanese yen, the Euro, the British pound, the Swiss franc, the Canadian dollar, and the Australian dollar.
The currencies market exists for two main reasons. Governments or companies need a way to convert any profits made in other countries’ currencies back to their own currencies when they sell goods or services abroad. These transactions account for 5 percent of the exchanges made in the Forex market.
The Forex market differs from U.S. markets in many ways. For one thing, the currencies market never sleeps; it trades 24 hours per day, 5 and a half days a week. Trading starts on the morning of Sunday and closes on the afternoon of Friday. Since the currencies market involves the whole world, trading always begins in Sydney, Australia, then moves all over the world as financial markets open and close. Also, since the market is global, there is no centralized exchange, such as the NYSE.
How It Works: An Example
This is how the currencies market works. If a trader has US dollars in his hand and he speculates that the US dollar will weaken compared to the Japanese yen, he will go to the Forex market and sell his US dollars so he can buy Japanese yen. The trader will then receive Japanese yen in the amount equivalent to the amount of his US dollars. Over the next few days and weeks, the situation may change; it may be that the Japanese yen will start to weaken compared to the US dollar. Thus, the trader goes back to the Forex market to sell his Japanese yen and buy US dollars. Since the US dollars has increased, the trader will now receive a larger amount of US dollars than what he had to begin with; in this way, he made a clean profit simply by exchanging currencies.