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What Is Forex Trading and How Does It Work?
The Forex market is arguably one of the most lucrative and traded markets in the world and since many market sectors depend on currency rates, the Forex market can also be an important and influential one to the overall economy. Therefore, gaining a broader understanding of the Forex market can help traders and investors understand the trajectory of the market as a whole.
So what is Forex trading, what moves its Forex prices, how do you read a Forex quote and how do you trade it? Here’s what you need to know about the Forex market:
What Is the Forex (Foreign Exchange) Market?
The foreign exchange market, otherwise known as Forex, or FX, is essentially the global market in which the transaction (buying and selling) of currencies takes place.
How Currencies Are Traded
It is important that there are 3 main types of Forex markets and these are spot, forward, and Futures.
Spot Forex
As the name entails, spot Forex takes place on the spot, and it is one of the most practiced types of transactions. For example, when someone wants to travel abroad they usually transact their country’s national currency with the foreign currency of the country to which they intend to travel. Since this type of Forex market is immediate, this also means that the currencies are exchanged using the current market rate at the time of the transaction.
Futures Forex
Forex Futures are legally binding contracts between two parties obligating them to buy or sell a specific amount of a currency at a fixed date, price, and quantity in the future. Traded on organized exchanges like the Chicago Mercantile Exchange (CME), trading Futures on Forex is regulated by relevant financial institutions.
Forward Forex
Forward Forex involves the agreement between two parties to transact a currency at a preset price and date in the future. This is similar to Futures Forex but differs because the transaction is not conducted on an organized exchange.
What Moves the Forex Market?
Macroeconomics and Monetary Policies
Perhaps some of the obvious factors that could influence Forex prices are macroeconomic conditions like inflation rates and monetary policy decisions like interest rate hikes. While the effects of these factors are not black or white, usually, higher inflation rates tend to decrease the purchasing power of a country's currency, hence affecting the overall Forex market and vice versa.
Geopolitics
A country’s political and geographical stance has an effect on its currency prices and on currency trading. For example, countries that have strong trade and exportation generally have stronger economies and currencies.
Market Sentiment
Market sentiment is, traders, investors, and market participants’ attitudes toward a certain market or financial asset. As such, if traders adopt a more positive outlook on currencies, it might positively affect the Forex market and vice-versa.
Pros and Cons of Trading Forex
Like in every market, the Forex market has its own pros and cons. One of the possible advantages of Forex trading is the Forex market’s high liquidity since it is known to be the biggest market in the world and, as such, has higher liquidity.
In addition, this market is considered one of the most accessible markets in relation to other markets that may be more complicated or pricey. Finally, another possible pro of trading Forex is the potential for fast returns, since this market is a fast-paced and dynamic one.
Nonetheless, despite the fact that it can have fast returns, the Forex market can also be volatile and a bit challenging for non-experienced traders. This also means that Forex may not be suitable for traders seeking longer-term returns or those who do not know how to handle fast price swings.
How to Read a Forex Quote
Regardless of the type of Forex trading you choose to embark on, knowing how to read a Forex quote is one of the basics of understanding Forex trading.
To put it simply, when reading Forex pairs you should keep in mind that the first currency is the base currency whereas the second one is the quote or counter currency. This means that if you have, for example, a EUR/USD currency pair then the euro is the base currency while the US dollar is the quote. Therefore, it represents the cost of purchasing one euro in dollars.
In other words, if the EUR/USD is priced at 1.3, then it essentially means that it takes 1.3 US dollars to buy one euro.
Forex Market Hours
Forex trading can be conducted 24 hours a day throughout the week except for on the weekends. As for the time zones, Forex market hours can be segmented into 4 main time zones that are Sydney session, the Tokyo session, the London session, and the New York session.Forex Futures at the CME trade limited hours compared to spot and forward, but are still available for trading 23 hours Sunday through Friday.
How to Trade Forex
If the aforementioned information appeals to you, and you believe that Forex trading can be suitable for your needs, then with Plus500’s trading platform, you can trade Futures contracts on Forex.