In order to grasp the concept of the Forex market, it's important to first have a clear understanding of what a market is. Essentially, the Forex market is a continuous cash market where different nations' currencies are traded. It is the largest financial market worldwide, with a daily turnover of over $5 trillion, which is more than three times the combined total of the US Equity and treasury markets.
Unlike other financial markets, the Forex market does not have a physical location or a central exchange. Instead, it operates through an electronic network that connects banks, corporations, and individuals who trade one currency for another.
This lack of a physical exchange allows the Forex market to operate 24 hours a day, moving from one time zone to the next and spanning across major financial centres around the world. The international Forex market is open for trading five days a week, from Sunday evening to Friday evening, and remains closed during weekends.
The main goal for traders in the Forex market is to profit from buying and selling foreign currencies. The exchange rates of all currencies are constantly changing due to shifts in supply and demand, which can be influenced by various factors such as economic, political, and natural events. These fluctuations in exchange rates present opportunities for traders to buy currencies at a lower price and sell them at a higher price, following the principle of "buy low, sell high".
In general, the Forex market consists of four main groups of participants. The most influential players are the major banks, bank associations, and central banks such as the European Central Bank, the Bank of England, and the Federal Reserve of the US. These entities, along with the entire bank community involved in currency exchange and credit operations, form what is known as the inter-bank market. The primary objective of central banks is not to make profits but to regulate currency rates and ensure stability in their respective economies. Often, central banks conduct their operations indirectly through major commercial banks, keeping their activities discreet. The banks in this group not only execute deals but also provide their own price suggestions, and they are referred to as market makers. They actively participate in the market by making deals worth millions and billions of dollars, using their own capital.
The second group of participants in the Forex market includes investment firms, insurance companies, pension funds, medium-sized banks, and large corporations. These players engage in currency exchange operations for investment purposes and business deals, and sometimes for long-term speculations. Notable examples include George Soros' Quantum fund, one of the largest investment funds in the world. These entities are capable of attracting billions in capital and can withstand even the intervention of central banks in the foreign exchange market.
The third group consists of financial companies that act as intermediaries between individuals and the market. They have overcome the barriers for individual participation in the Forex market and have made brokerage services accessible to people around the world, thanks to the development of the internet.
For individuals to participate in the Forex market, they need to go through brokerage firms. Brokers provide small investors with the opportunity to enter the market by opening a trading account and making a deposit. The minimum deposit requirements vary among brokers. It is worth noting that brokerage companies establish credit levels, known as leverage, to enhance clients' potential profits. Leverage allows traders to multiply their deposited amount and trade with larger lot sizes, only risking the money they have invested. For example, to trade with a 100,000 lot size at a 1:100 leverage ratio, a $1,000 deposit is required.
In the Forex market, the main trading instrument is currency. Currencies are represented by Latin symbols (ISO codes), with the first two characters indicating the country name, and the last character indicating the currency name.
All currencies in the Forex market are priced and traded in pairs, such as EUR/USD and GBP/USD. This is because when trading, one currency is sold in exchange for another. The first currency in the pair is known as the base currency, while the second currency is the quote currency. In notation, the pair can be written without a separating sign, such as EURUSD.
When a trader buys a currency pair, they are said to have opened a BUY position. When they sell the same currency pair in the future, it is referred to as closing a BUY position. Conversely, when a trader sells a currency pair, it is called opening a SELL position, and when they buy back the same currency pair, it is closing a SELL position. It is important to note that traders do not need to worry about obtaining the base currency for a SELL position or the quote currency for a BUY position, as these currencies are temporarily provided by the brokerage company.
When opening a BUY position, a trader makes a decision based on the exchange rate, which indicates how many units of the quote currency are needed to buy one unit of the base currency. The decision to open a SELL position is also based on the exchange rate, but this time it indicates how many units of the quote currency will be received when selling one unit of the base currency. The decision to buy or sell a currency pair depends on the trader's prediction of whether it will appreciate or depreciate. In most currency pairs, the quote currency is the US dollar. However, there are exceptions, such as USD/CHF, where the base currency is the US dollar and the quote currency is the Swiss franc.
The cost of the base currency is measured in terms of the quote currency, and this measurement accuracy is known as a pip. For most currency pairs, the accuracy is up to four decimal places, indicating a pip value of 0.0001. However, there are exceptions, particularly in pairs involving the Japanese yen (JPY), where the accuracy is up to two decimal places, meaning a pip value of 0.01. In some trading platforms, currency values are increased by an additional decimal place, resulting in five digits for most pairs and three digits after the decimal point for yen pairs.
