Menu
How does forex work?
The simple buying and selling of foreign currency in addition to the conversion of company profits from foreign sales into domestic currency makes up five percent of foreign exchange trading. The other ninety-five percent is from speculation for profit, where traders guess how much the currency rate is going to be a specific period of time. While any currency can be considered in forex, the major ones – U.S. dollar, Japanese Yen, the Euro, British Pound sterling, Swiss Franc, Canadian and Australian dollar – are the most commonly exchanged currency.
In order to work with forex, you need to understand how to read a foreign exchange quote. The two keys to this is remembering that the first currency listed on the quote is the base currency – what everything is being exchanged against – and that the base currency always as a value of 1. Most quotes use the United States dollar as the base currency. If the quote increases, the dollar has strengthened. If the quote decreases, the dollar has weakened. This means the trader can buy more or less of the foreign currency.
The British pound sterling, the Australian dollar, and the Euro are the only exceptions to the base currency rule. These three currencies can be the base in a quote instead of the American dollar. When this happens, things change a little bit. It the quote is in one of these three currencies and the quote rises, then the American dollar is weakening and the base currency is getting stronger. These are called cross currencies, but the way the forex works is the same.
Who is involved in forex trading?
Foreign exchange market trading is made up of numerous levels, starting with investment banking firms all the way at the top. Where a particular trader lands in the numerous levels of trading will depend on just how volume of buying and selling of currencies they can do. Institutions that deal with pensions, insurance, mutual funds and other investments have started to work their up and become larger players in the forex market.
Banks are the most common member of the forex trading community. They cater to both commercial and speculative trading on a daily basis. While some of the transactions could be for customers – a vacationer exchanging dollars for pounds while visiting England perhaps – most to the trading is done for their bank’s use. Most banks have their own brokerage division and everything is now done online.
Commercial firms are the next biggest forex traders. They are simply looking for foreign exchange in order to pay for goods or services. While most of these trades are small transactions performed at a bank and have little to no effect on currency exchange rates, some multi-national, multi-billion dollar companies do have an effect that is usually unpredictable.
There are others who are involved and use forex trading in their everyday business. National central banks in a country help control monetary supply and demand, inflation rates, and interest rates, including target rates for the currencies they deal in. These are the users that help stabilize markets and are not prone to bankruptcy. Investment firms manage large accounts for their customers and they work with foreign securities. They are not speculative or aimed for profit. Instead they ‘invest’, looking for the best rates for their customer’s money. Retail brokers and traders are the smallest group in the forex community and they usually deal solely with other brokers or banks.