Introduction to Forex

Forex is the abbreviated term commonly used to refer Foreign Exchange market. It is a global decentralized or over-the-counter currency trading market.  Buying, selling and exchaging of foreign currencies takes place at current or predetermined rates. Trillions of dollars are traded on an average per day making it the largest and the most liquid market in the world. 

The Forex market is open 24 hours a day, five days a week except for weekends and holidays. The major markets of Forex are London, New York, Tokyo, Zurich, Singapore, Frankfurt, Hongkong, Paris and Sydney. All levels of traders from Central banks of countries to individual travellers to trade foreign currencies in Forex market. Transaction range from imports and exports of goods to speculations with no underlying goods or services. 

What is Forex rate?

Forex rate is the rate at which one currency will be exchanged for another. It is the value of a unit of one country's currency to another currency. It fluctuates daily according to the market. In Forex market trading takes place by converting one currency to another.  The market works through financial institutions mostly banks at several levels. The financial firms who are involved in Foreign Exchange trading are called dealers. The trades can be in hundreds of millions of dollors. There are three major types of Foreign exchage trading.

 

Spot transaction

A spot deal or transaction is an immediate transaction which is carried out in two days for most currency pairs. Exception to this is the trade between US Dollar and Canadian Dollar, Turkish Lira, Euro and Russian Ruble which settle the next business day. During holidays like Christmas spot transactions my take up to six days or even more to settle.

Direct exchage of currencies in the form of cash takes place in this type of transaction. Money is exchaged on the value date at the price established on the trade date. It has the shortest time frame as it involves trade of cash. It is one of the most common types of Forex Trading. The US Dollar is the most commonly traded currency.

Forward transaction

In a forward transaction, trading doesn't takes place immediately. A buyer and seller negotiate and come to an agreement to transact any amout at an agreed rate on any future date that's not a weekend or a holiday.

The rate is calculated based on the spot rate plus or minus the diferrential rate of interest between the two currencies. This differential rate of interest is called forward points. Money is exchanged on the maturity date at the price set on the trasaction date. The transaction occurs at the agreed price regardless of what the market prices are on that day. This type of transaction is made to deal with the risks involved in Foreign Exchange trade.


Future transactions

A future transaction is similar to a forward but can be executed only for specific amounts and sppecific settlement dates. The buyer has to pay a portion of the value upfront. The value is marked-to-market daily and the buyer pays or receives money based on the changing value. Sometimes when an adverse event happens, it may affect the market conditions. During such times traders liquidate their risky assets and shift them to less risky ones. This behaviour is called risk aversion. US Dollar is considered a safe currency and traders prefer converting their risky currency to US Dollar during such adverse markets situations. Some currencies have low interest rates and some higher. The act of borrowing a currency that has lower interest rate in order to purchase currency with a higher rate is referred to as Carry trade.

Forex influencers

At the top of the level are the large commercial banks and securities dealers. There two prices bid and ask price. The difference between the bid and ask price widens as the level goes down. Then come the commercial companies that trade small amouts but play a major role in Forex market. Some Multinational companies are also involved in this level of Forex market. Central banks also play a major role in money supply, inflation and interest rates. Investment maagement firms use the Forex market to transact in foreign securities. Retail and non banking foreign exchange traders also form a large part of Foreign Exchange traders.

 

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