i. Currencies are traded in pairs.
ii. The forex market is a global over the counter decentralized marketplace for the exchange of foreign currencies.
iii. Forex trading happens over an electronic communications network which is an interbank network.
What is forex?
Foreign Exchange is the process of changing currencies. One currency is changed into another currency for various reasons.
Foreign Exchange takes place for business purposes, investment purposes, and even for tourism purposes. Forex is a shorter word for Foreign Exchange.
Foreign Exchange is basically currency changing hands from buyers and sellers at an agreed price.
This exchange of currency is done for various practical reasons making it the most volatile asset with the highest daily turnover of $ 6 Trillion worth of foreign currencies being traded daily.
How does forex work?
Whenever a foreign currency is to be traded on the foreign exchange market, these foreign currencies are traded in pairs.
Hence, if a trader wants to trade the Dollar, they can’t just trade the standalone Dollar currency, they will have to trade either a pair of the Dollar and the Pound or the pair of Dollars and the Euro.
Trading in the currencies is always done by selling one currency to buy another, hence the price quotes of currencies that we see are basically how much the base currency is worth in the quote currency.
The currencies are listed as a three-letter code, of which the first two letters stand for the name of the country and the third stands for the currency of the country.
For example, INR, IN – India, R – Rupee; USD, US – United States, D – Dollar.
Let us consider the currency pair of USDEUR, trading at 0.8250. In this, the Dollar is the base currency and the Euro is the quote currency.
This is read as, currency pair of the Dollar Euro, quote price is 0.8250, which means that 1 Dollar is equal to 0.8250 Euro at that moment.
The foreign exchange market or the forex market is the place where the exchange of currencies takes place.
The technical definition of forex market is that it is a global decentralized or over-the-counter market for trading the currencies. Let’s understand what this actually means.
The forex maret is a global market, hence it is accessible to individuals around the globe. It is a decentralized market which means that no single organization or institution controls the affairs of the market, it is a free and fair market.
An over-the-counter market means that the exchange of currency between two parties takes place directly between them without any third-party supervision.
Forex trading also does not take place at a physical or central location but is done over the Electronic Communication Networks (ECN) in various markets around the world.
Unlike other asset classes such as equities and commodities, Forex is traded on the forex market 24 hours a day 5 days a week from Monday to Friday.
The markets are open 24 hours a day is because of the different international time zones of countries. At any given time at least one market is open which allows trading to take place for 24 hours a day.
The daily Forex trading session starts with the opening of the Australian markets followed by the European and American markets.
It is a normal thing for one country’s market timings to overlap another country’s market timings and these overlapped periods are the most active periods of trading.
It is said that the New York and London session is the most active trading session.
The market hours are such because the forex markets consist of participants such as banks, corporations, hedge funds, asset management firms as well as retail participants.
These participants are situated in different countries around the world and they access the forex markets according to their time zones, hence the 24 hours a day timing of the forex market.
Forex market drivers
Since the forex market has currencies from all over the world listed, it gets lots of attention from individuals all over the globe for participating in them.
The prices of the currency pairs are determined by transactions that take place between the buyers and sellers, but the actual factors that determine Forex prices are different.
Forex prices are primarily determined by the forces of demand and supply prevalent in the market, this demand and supply are influenced by the following:
1. Economic data
These are reports that are released either by government authorities or by private authorities that indicate the economic condition of countries.
The economic data of a country influences the currency of the country as it indicates whether the country will see growth or decline.
News releases have a good influence on currency prices. This news adds to the volatility of the Forex Market.
News releases could be about an election result or about some war breakouts.
Forex Market participants keep check over such news releases that can affect prices of currencies.
3. Central banks
These banks are the federal banks of countries that control the supply of the currency in the market.
The actions of central banks of leading countries in the forex market have been affecting the entire forex market.
4. Market sentiment
The sentiment of the participants is a collective influence of the above-mentioned factors, that have effects on the forex market.
Confidence in a country’s currency will cause the currency’s value to soar, while uncertainty will cause the currency to lose value.