Foreign Exchange (forexor FX) is the trading of onecurrencyfor another. For example, one can swap the U.S. dollar for the euro. Foreign exchange transactions can take place on the foreign exchange market, also known as theForex Market.
The forex market is the largest, mostliquid marketin the world, withtrillions of dollarschanging hands every day. There is no centralized location, rather the forex market is an electronic network of banks, brokers, institutions, and individual traders (mostly trading through brokers or banks).
Foreign Exchange (forex or FX) is a global market for exchanging national currencies with one another.
Foreign exchange venues comprise the largest securities market in the world by nominal value, with trillions of dollars changing hands each day.
Foreign exchange trading utilizes currency pairs, priced in terms of one versus the other.
Forwards and futures are another way to participate in the forex market.
The market determines the value, also known as anexchange rate, of the majority of currencies. Foreign exchange can be as simple as changing one currency for another at a local bank. It can also involve trading currency on the foreign exchange market. For example, a trader is betting a central bank will ease or tightenmonetary policyand that one currency will strengthen versus the other.
Whentrading currencies, they are listed in pairs, such as USD/CAD, EUR/USD, or USD/JPY. These represent the U.S. dollar (USD) versus the Canadian dollar (CAD), the Euro (EUR) versus the USD and the USD versus the Japanese Yen (JPY).
There will also be a price associated with each pair, such as 1.2569. If this price was associated with the USD/CAD pair it means that it costs 1.2569 CAD to buy one USD. If the price increases to 1.3336, then it now costs 1.3336 CAD to buy one USD. The USD has increased in value (CAD decrease) because it now costs more CAD to buy one USD.
In the forex market currencies trade inlots, called micro, mini, and standard lots. A micro lot is 1000 worth of a given currency, a mini lot is 10,000, and a standard lot is 100,000. This is different than when you go to a bank and want $450 exchanged for your trip. When trading in the electronic forex market, trades take place in set blocks of currency, but you can trade as many blocks as you like. For example, you can trade seven micro lots (7,000) or three mini lots (30,000) or 75 standard lots (750,000), for example.
The foreign exchange market is unique for several reasons, mainly because of its size.Trading volumein the forex market is generally very large. As an example, trading in foreign exchange markets averaged $5.1 trillion per day in April 2016, according to the Bank for International Settlements, which is owned by 60central banksand is used to work in monetary and financial responsibility.
The largest trading centers are London, New York, Singapore, and Tokyo.
Themarketis open 24 hours a day, five days a week across major financial centers across the globe. This means that you can buy or sell currencies at any time during the day.
The foreign exchange market isnt exactly a one-stop shop. There are a whole variety of different avenues that an investor can go through in order to execute forex trades. You can go through different dealers or through different financial centers which use a host ofelectronic networks.
From a historical standpoint, foreign exchange was once a concept for governments, large companies, andhedge funds. But in todays world, trading currencies is as easy as a click of a mouseaccessibility is not an issue, which means anyone can do it. In fact, manyinvestment firmsoffer the chance for individuals to open accounts and to trade currencies however and whenever they choose.
When youre making trades in the forex market, youre basically buying or selling the currency of a particular country. But theres no physical exchange of money from one hand to another. Thats contrary to what happens at a foreign exchange kioskthink of a tourist visiting Times Square in New York City from Japan. He may be converting his (physical)yento actual U.S. dollar cash (and may be charged a commission fee to do so) so he can spend his money while hes traveling.
But in the world of electronic markets,tradersare usually taking a position in a specific currency, with the hope that there will be some upward movement and strength in the currency that theyre buying (or weakness if theyre selling) so they can make a profit.
There are some fundamental differences between foreign exchange and other markets. First of all, there are fewer rules, which means investors arent held to as strict standards or regulations as those in the stock, futures oroptionsmarkets. That means there are noclearing housesand no central bodies that oversee the forex market.
Second, since trades dont take place on a traditional exchange, you wont find the same fees orcommissionsthat you would on another market. Next, theres no cut-off as to when you can and cannot trade. Because the market is open 24 hours a day, you can trade at any time of day. Finally, because its such a liquid market, you can get in and out whenever you want and you can buy as much currency as you can afford.
Spot for most currencies is two business days; the major exception is the U.S. dollar versus the Canadian dollar, which settles on the nextbusiness day. Other pairs settle in two business days. During periods that have multiple holidays, such as Easter or Christmas, spot transactions can take as long as six days to settle. The price is established on the trade date, but money is exchanged on thevalue date.
The U.S. dollar is the most actively traded currency. The most common pairs are the USD versus theeuro, Japanese yen, British pound and Swiss franc. Trading pairs that do not include the dollar are referred to as crosses. The most common crosses are the euro versus the pound and yen.
The spot market can be very volatile. Movement in theshort termis dominated by technical trading, which focuses on direction and speed of movement. People who focus on technicals are often referred to aschartists. Long-term currency moves are driven by fundamental factors such as relative interest rates and economic growth.
A forward trade is any trade that settles further in the future than spot. Theforward priceis a combination of the spot rate plus or minus forward points that represent theinterest rate differentialbetween the two currencies. Most have a maturity less than a year in the future but longer is possible. Like with a spot, the price is set on the transaction date, but money is exchanged on the maturity date.
Aforward contractis tailor-made to the requirements of the counterparties. They can be for any amount and settle on any date that is not a weekend or holiday in one of the countries.
Afuturestransaction is similar to a forward in that it settles later than a spot deal, but is for standard size and settlement date and is traded on a commodities market. The exchange acts as thecounterparty.
A trader thinks that the European Central Bank (ECB) will be easing its monetary policy in the coming months as the Eurozones economy slows. As a result, the trader bets that the euro will fall against the U.S. dollar and sellsshort€100,000 at an exchange rate of 1.15. Over the next several weeks the ECB signals that it may indeed ease its monetary policy. That causes the exchange rate for the euro to fall to 1.10 versus the dollar. It creates a profit for the trader of $5,000.
By shorting €100,000, the trader took in $115,000 for the short-sale. When the euro fell, and the trader covered their short, it cost the trader only $110,000 to repurchase the currency. The difference between the money received on the short-sale and the buy to cover is the profit. Had the euro strengthened versus the dollar, it would have resulted in a loss.
The offers that appear in this table are from partnerships from which Investopedia receives compensation.
Forex (FX) is the market where currencies are traded and the term is the shortened form of foreign exchange. Forex is the largest financial marketplace in the world. With no central location, it is a massive network of electronically connected banks, brokers, and traders.
A currency pair is the quotation of one currency against another.
A spot exchange rate is the rate of a foreign-exchange contract for immediate delivery.
Currency pairs are two currencies with exchange rates coupled for trading in the foreign exchange (FX) market.
Novice or introductory traders can use micro-lots, a contract for 1,000 units of a base currency, to minimize and/or fine-tune their position size.
Cable is a term used among forex traders referring to the exchange rate between the U.S. dollar (USD) and the British pound sterling (GBP).