What is Forex – Foreign Exchange?
One of the questions we get asked all the time is “What is forex trading?” When did it start? How big is it? Who are the major players? What makes currency rates change?
Here are the answers to all your questions!
What is forex?
Forex is the international market for the free trade of currencies. Traders place orders to buy one currency with another currency. For example, a trader may want to buy Euros with US dollars, and will use the forex market to do this.
The forex market is the world's largest financial market. Over $4 trillion dollars worth of currency are traded each day. The amount of money traded in a week is bigger than the entire annual GDP of the United States!
The main currency used for forex trading is the US dollar.
When did forex start?
As the world continued to tear itself apart in the Second World War, there was an urgent need for financial stability. International negotiators from 29 countries met in Bretton Woods and agreed to a new economic system where, amongst other things, exchange rates would be fixed.
The International Monetary Fund (IMF) was established under the Bretton Woods agreement, and started to operate in 1949. All exchange rates changes above 1% had to be approved by the IMF, which had the effect of freezing these rates.
By the late 1960's the fixed exchange rate system started to break down, due to a number of international political and economic factors. Finally, in 1971, President Nixon stopped the US dollar being converted directly to gold, as part of a set of measures designed to stem the collapse of the US economy. This was known as the Nixon shock, and lead to floating rate currency markets being established in early 1973. By 1976, all major currencies had floating exchange rates.
With floating rates, currencies could be traded freely, and the price changed based on market forces. The modern forex market was born.
Who trades on the forex market?
There are many different players in the forex market. Some trade to make profits, others trade to hedge their risks and others simply need foreign currency to pay for goods and services. The participants include the following:
- Government central banks
- Commercial banks
- Investment banks
- Brokers and dealers
- Pension funds
- Insurance companies
- International corporations
When is the forex market open?
Unlike stock exchanges, which have limited opening hours, the forex market is open 24 hours a day, five days a week. Banks need to buy and sell currency around the clock, and the forex market has to be open for them to do this.
What factors influence currency exchange rates?
As with any market, the forex market is driven by supply and demand:
- If buyers exceed sellers, prices go up
- If sellers outnumber buyers, prices go down
The following factors can influence exchange rates:
- National economic performance
- Central bank policy
- Interest rates
- Trade balances – imports and exports
- Political factors – such as elections and policy changes
- Market sentiment – expectations and rumours
- Unforeseen events – terrorism and natural disasters
Despite all these factors, the global forex market is more stable than stock markets; exchange rates change slowly and by small amounts.
What are the advantages of the forex market?
The forex market has many advantages. These include the following:
- It's already the world's largest market and it's still growing quickly
- It makes extensive use of information technology – making it available to everyone
- Traders can profit from both strong and weak economies
- Trader can place very short-term orders – which are prohibited in some other markets
- The market is not regulated
- Brokerage commissions are very low or non-existent
- The market is open 24 hours a day during weekdays