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What is Forex?

What is Forex?

Forex stands for the foreign exchange market. This is also referred to as the FX, Spot FX or Currency market. All of these names are just several ways of describing the very same market.

This market has been around since the 1970’s when currencies started to fluctuate when President Nixon took the U.S. off of the gold standard. Formerly, the U.S. currency was backed by gold and now it’s just backed by the “faith” in the government’s ability to honor and back the currency.

However, even though this market has been around for such a long time, it hasn’t been open to the retail public until the 1990’s and many market makers didn’t even get well established until 2000 or after.

Formerly, only the “big boys” could play around in this market. They usually had a minimum of $10 million to $50 million to throw around in this market. It was reserved basically for banks and big institutions.

However, with the advent of the internet, later on it was able to be opened up to the retail public as they were allowed to trade in smaller sizes that would be feasible for the “average Joe” to be able to handle.

Size of the Forex Market

The Spot Forex market is the largest financial market in the world, with a volume of $4 trillion average daily trading volume. Now let’s put that into perspective. The New York Stock Exchange (NYSE) trades about $25 billion a day. So not only does this dwarf the trading volume of America’s largest stock exchange but if you combined the volume of ALL stock markets around the world, you still haven’t equaled the daily volume in the forex market.

Currency exchange Forex trading is simply the trading (exchanging) of money. It involves the simultaneous buying of one currency and the selling of another. The “exchange rate” is what you will see quoted. This determines how much currency that another currency can buy.

You will find that there will be many factors that cause these exchange rates to go up and down. Ultimately, the exchange rate is determined by the confidence that the world collectively has in a particular currency. This will be made up of many facets: how their economy is doing, political stability, consumer sentiment, the trend direction of these exchange rates on the charts, etc.

Where are these currencies traded in the forex market?

Trading stationThe good part about forex trading is that you don’t have to “literally” exchange money or set up foreign bank accounts or any of that nonsense. No, it’s as simple as opening up an account with a forex dealer (aka market maker…some even refer to them as brokers). They aren’t technically brokers and that’s why there’s not a commission in this market. It’s because you are dealing directly with the market maker. Market makers charge spreads (the difference between the buy and sell quote…which we’ll delve into more later) and brokers charge commissions.

In your stock brokerage account, you incur a buy commission from your stock broker, a spread cost from the market maker and a sell commission from your stock broker. So there are three fees by the time you’ve bought and sold a stock. However, in forex, you don’t have the commissions and even the spread you pay is less than that of stocks when you consider how much currency you are controlling.

Important note here!

Make sure to open your account with a well capitalized, regulated market maker. I’ll suggest some to check out here. There are many reputable market makers out there such as: FXCM.com, Oanda.com, Forex.com. GFTforex.com, etc. Your market maker ideally needs to be regulated in one of the following countries: the U.S., Canada, the U.K., or Hong Kong.

These are the countries that regulate the best and hold their market makers to the most stringent requirements. The last time I checked, FXCM.com had the best combination of capitalization and regulation in multiple countries. However, check all of this out for yourself at each of these market makers and see what you feel is best for you.

How are currencies traded?

They are traded in pairs. Why? Because a currency can be strong vs. one currency but weak vs. another. Remember that currency values are the collective sentiment of investors around the world. Currency rising

So if investors feel good about the U.K. economy and worse about the U.S. economy, then the British pound (GBP) will gain in strength to the U.S. dollar (USD). However, at the same time, investors could still feel better about the U.S. economy than that of Japan. If so, the USD would go up against the JPY (Japanese yen). So as you can see, it’s all relative to what it’s being compared to. In the first instance, the U.S. dollar is viewed as being weak (in comparison to the pound). In the second example the “buck” was viewed as being strong vs. the yen.

So these currencies are traded in the interbank market through these forex market makers. The market makers set the quotes based off of the buying and selling pressures that they see due to the demand for a currency vs. another.

Currencies trade in the spot forex market as OTC (over the counter). That simply means that they do not trade on a certain designated exchange around the world. An example that you might be more familiar with is the NYSE and the NASDAQ. The NYSE is an actual exchange that has a physical location where stocks are traded. The NASDAQ, on the other hand, is an OTC market where there is no physical place that you would see these traded. They are just two different ways that stocks are traded.

Generally, if you see a stock traded that has a 4 letter symbol, it’s traded on the NASDAQ. However, if it’s 3 letters or less, then it’s traded on an exchange such as the NYSE.

An advantage of an OTC market is that market makers have to compete for your business more than a specialist would have to on a physical exchange. Therefore, this ends up working in the actual trader’s favor.