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How does Foreign Exchange work?

What is foreign exchange or forex?

In this post we will give you a brief overview of how forex works. We will take a look at forex meaning, where and how it is traded, the size of the market and several other important things related to forex.

The concept of forex might sound confusing and alien to some, but the principle behind it is rather simple and time-tested. In fact, the first mentions of it hail from the biblical times. Trading one currency against another is known as foreign exchange or, more commonly, forex. A simple example of forex exchange would be trading US dollars for British pound sterling.

The forex market is the largest and the most liquid global market with many trillions of dollars trading everyday throughout the world. Forex trading has no central control point and consists of a large and diverse network of brokers, bankers, individual traders, institutions and investors. 

Foreign exchange definition

The value of each currency is determined by the market, and is known as the exchange rate. Forex trading can be done in various ways. Exchanging one currency for another at your local bank is also forex trading, but you can also trade currency at a foreign exchange, which is known as investment trading. 

There are several things that make the foreign exchange market very unique. The biggest reason is the sheer size of the market. The volumes traded at a forex market are usually very large and can sometimes exceed 5-6 trillion dollars per day. This makes the foreign exchange market one of the largest and most robust markets in the entire world. 

Foreign exchange market trading

Foreign exchange services are operating 24 hours, 5 days a week in most regions of the world. This means you have the chance to buy and sell currencies around the clock for 5 days a week. 

You cannot classify the forex exchange market as a one-stop shop. There are various diverse avenues that any investor can explore before choosing the one best suited to your needs. You have the chance to conclude various deals through different financial centers that use a host of electronic networks. 

Looking back at the history of forex exchange, it used to be mostly suitable for hedge funds, governments and large companies, but today things have changed. Today, with just a few clicks of a mouse, you can also access the huge financial market as a full-scale investor. Most of the large investment companies allow individual traders and investors to open accounts with them and start their forex exchange journey.

What is the true size of the forex exchange market?

The foreign exchange is one of the most liquid financial markets in the world and it completely dwarfs the trading volume of other markers such as bonds and stocks. According to recent analysis, the forex exchange market trading volume reaches around $6.6 trillion on an average trading day. Comparing these numbers to other trading markets such as shares and bonds, gold and cryptocurrency, one can easily see how huge the forex trading is. The gold market is barely over a trillion dollars and crypto has just touched the one-trillion mark but in the forex market, trillions of dollars change hands every day on most days of the year.

How does currency exchange work?

When you are trading in the forex market, what you are doing is essentially buying the currency of one country while simultaneously selling the currency of some other country. But during a forex trade, there is no physical exchange of money between parties and everything is done on the computer screen. Traders will usually take a position with a certain currency in the hopes that it will perform as expected, and they will be able to sell their position at a better price, thus making a profit. In today’s digital world, doing foreign exchange trading is very simple and easy. 

How is the foreign exchange market different from other markets?

There are some key differences between foreign exchange and other markets. For starters, there are no boards or central bodies to regulate and manage the forex markets, which means traders don’t have to face strict standards and regulations as do traders in the futures, stocks and some other markets. There are also no cut-off times (apart from the weekends), which means you can trade at any given time of the day. Finally, the high liquidity offered by forex exchange markets makes it one of the best trading alternatives. 

Summary

In this post we discussed foreign exchange meaning, its market size, how people can become traders and what are the important things to keep in mind when considering a foray into forex trading. This post should serve as a starting point for anyone who is looking to get into forex exchange trading.

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