What Is Forex Anyway?
Have you ever heard of Forex?
You most likely have. But what is this strange word so many people seem to be throwing around nowadays?
Forex is a catchy portmanteau of ‘foreign currency’ and ‘exchange,’ which should help you determine what it is: a global market where you can trade foreign currencies against each other.
The Forex market is also the biggest in the world, trading an average of a whopping $5.1 trillion every day. However, Forex isn’t as elusive as people might think. If you’ve ever traveled to another country and exchanged your home country’s currency for the currency of the country you were now in, you’ve done some “lo-fi” Forex trading.
But the big leagues are a whole new ballgame. Since the market is decentralized and therefore spread across the globe, Forex trading never stops. Just as the sun is going down in one area of the world, so it is rising in another, and with it, new Forex trading opportunities.
How did this incredible market get its start, though? Interestingly, its history goes back to sometime around the middle of the last millennium in the Netherlands, when the concept of foreign currency was first established. However, the modern Forex market we know only began to take shape in the latter half of the 20th century, when the 1971 accord of Bretton Woods allowed foreign currencies to float freely against each other. People noticed that the values among foreign currencies varied greatly, and therefore, the need for a wholly new trading market was born.
So how does this all work? For starters, you buy and sell currencies simultaneously. The profits come from speculating on the future trends of these currencies. It gets a bit more complicated when you split the overall Forex market into three sub-markets: spot markets, futures markets, and forwards markets. While the futures market was once the top dog for its longer availability times, spot markets have since taken the number one spot. Spot markets have always been popular, though, mainly because their underlying assets are what the other two markets go off of.
Moreover, currencies in the spot markets are bought and sold according to their current prices. These prices are determined by supply and demand and often provide a valuable window into geopolitical situations, current interest rates, and economic performance, among other things. Surprisingly, you can learn a lot about the current state of the world through Forex.
Forwards markets are a little bit different than the other two. In these markets, two parties buy and sell contracts over the counter (OTC), and then mutually set the terms of their agreement. Like futures contracts, forwards contracts are binding and are usually settled for cash upon their contract’s expiry. You can also settle before the expiry if you so choose. What makes forwards and futures markets so attractive to traders is that they mitigate the risk of trading currencies. That alone is incentive enough to test the waters in these markets.
Hopefully, you’ve learned a little something about Forex and how it works. Thanks for reading and happy investing!