Forex is the exchange of the currencies of two different countries. The objective is that this exchange is favorable or at least does not produce significant losses.
Although Forex is used by banks, tourism, large companies, hedge funds, investors and governments and central banks, it is not alien to the lives of people who do not participate in business.
Let’s take an example that helps us understand. We need to travel from the United States to Europe and we have an amount of dollars. Both the dollar and the euro experience daily fluctuations in their value. We then seek to make the change in those days where the exchange favors us.
Large Forex investors are not interested in receiving the currency physically but in the benefits that would be obtained by making good predictions of the price of currencies in the market.
What is it?
Forex is a currency market, also known as FX and is used by a network of buyers and sellers who exchange short and medium term currencies for an agreed price. It operates throughout the world, is decentralized and is based on the exchange of one currency for another. The objective? obtain benefits with the purchase and sale of goods and services abroad or through speculation.
- Around the world, operations for about four trillion dollars are handled daily. This figure beats all other stock markets, so there are many opportunities for this type of investment.
- The value of currencies changes depending on how many are converted daily, in other words, by supply and demand, and that generates volatility. The fluctuation of prices implies that the risks and benefits can be very high in this market. This volatility and ability to predict changes in value and determine the time to make changes in currencies, which makes it attractive.
All Forex trades bet on the value of one currency relative to the other. Currency pairs have a three-letter code, in which normally the first letters correspond to the main currency and the second to the secondary currency.
For example, the GBP / USD is a pair formed by the British pound and the US dollar, the pound being the currency that is sold, obtaining the dollar in exchange. The difference between both buying and selling prices of a currency pair is known as the spread.
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How are currency pairs classified?
Depending on the importance in the global market and the volume of trade there are some currency pairs that are more attractive than others. Depending on their commercialization, they can be classified into:
- Major currency pairs They represent 80% of the foreign exchange market, and due to their liquidity and availability, they give advantage to the negotiation conditions.
- Minor currency pairs They have less liquidity and are often called currency crosses and have the peculiarity that they do not include the US dollar.
- Exotic currency pairs they involve currencies of emergent markets or a small economy, they are of low liquidity and volume of negotiation.
Types of contracts in Forex operations
- Forex Spot Market or Spot Contracts. This type of contract is agreed and executed in a short time and the price of the currency for the purchase and sale is fixed at the time of settlement.
- Forex forward market or installment contract. In these contracts, a specific price is stipulated and fixed at which the currency will be exchanged for the other on a date established in the future.
- Forex futures market. It works in the same way as the installment contract but it is legally binding, where the price and specific moment are established for the transaction with an expiration date.
How does the currency market work?
If the investor estimates that the euro will rise against the yuan, he will buy euros at the current price and once their value rises he sells them, thus making a profit.
Another way to profit would be by anticipating the devaluation of the yuan. Thus, the more the Chinese currency devalues against the euro, the greater its benefits. This is described as two kinds of trades, the first as a “go long” and the second as a “go short.”
Batch and leveraged trades
Normally the forex market is carried out in large batches to standardize operations. Then, private investors may be limited in their possibilities to carry out the operation by the large amounts that the purchase of the first currency implies.
Fortunately, Forex trading can be done through CFDs, which are products that allow you to pay only a fraction of the total value. This is called a leveraged market and allows you to pay a portion of the money without committing all the capital or having all the money available.
Features and advantages of the Forex market
- It represents the largest market in the world.
- Trade in any direction with a currency pair without limitations.
- It is traded directly between two parties unlike stocks and commodity markets.
- It occurs in a whole network of banks in different time zones so it can be invested 24 hours a day with a simple internet connection and a computer.
- It is agile, easily accessible and moves large amounts of money.
- It is a decentralized business with a wide variety of investors.
- It allows purchases and sales outside of its reference market between countries with different currencies.
- The brokers they facilitate buying and selling transactions in exchange for a small commission.
- You can open an account and start trading the currency market with just 50 euros.
Despite the great advantages offered by the foreign exchange market, it is always important to know that it is affected by the laws of supply and demand and therefore it is necessary to understand all the factors that generate price changes.