The foreign exchange market is widely known as "Forex". Here brokerage firms and banks are linked over an electronic network. This network enables them to convert the currencies of countries all over the world. It is the largest and the chief liquid financial market in the world. Dollar volume of dealing of currencies daily goes beyond $1.9 trillion dollars in the currency market. Sometimes it goes beyond even the total volume of all U.S. equities and future markets.
The Forex is often considered as being dominated by the government central banks, and commercial and investment banks. That is why private investors prefer to deal on the currency exchanges. It is easy for them to access via various technological innovations like the Internet.
Widely traded currencies include US Dollar, British Pound, Swiss Franc, Japanese Yen, Canadian Dollar and Australian Dollar. Trade in Forex is done for five days a week, round the clock with constant access to dealers throughout the world. It is not centered on any physical location or any exchange, as it is with the stock or future markets. Transactions take place between two corresponding persons over a phone line or through an electronic network.
Background
In the very beginning, there was a barter system i.e. exchange of goods with one another as per individual requirement. But its obvious limitations led to the establishment of mostly accepted channels of exchange.
Consequently, metal coins came to the scenario. However, paper form of governmental IOUs required approval in political administrations during the Middle Ages.
Prior to the First World War, most of the central banks moved ahead to support their currencies with convertibility to gold. But at times, this resulted in political instability due to devastating inflation. This was due to the expanding supply of paper money with no gold coverage. Therefore, Forex controls were initiated to protect local national interest.
Later on, during the Second World War, the USA introduced the Bretton Woods agreement in July 1944. As a result, this agreement led to a system of fixed exchange rates that re-established the gold standard to an extent and also stabilized the dollar at USD 35/oz. It also fixed the other prominent currencies to the dollar and thus made it permanent.
The last few decades have witnessed the developing of Forex trading into the largest global market. By now, all the restrictions from the capital flows have been put off in several countries. It has resulted in the independency of the markets to settle Forex rates as per their perceived values.
There are a number of reasons due to which Forex trading has gained popularity. The most prominent include available leverage, utmost liquidity round the clock a day and extremely low dealing cost, which relate to trading. Certain basics of Forex trading are as follows:
Margin Trading: Here trading is done generally on a margin basis. A larger position in the market can be acquired by a relatively small deposit.
Base and Variable Currency: Trading is done with the combination of two currencies. But two sides of trade are always there i.e. long (bought) and short (sold). Not always, but generally, the trade currency is with the highest value.
Spot and Forward Trading: This means that if no further step is taken, then, dealing will be settled after two business days.
Interest Rates Differentials: Different interest rates are paid by different currencies.
There are also other basics of Forex trading, but one thing is definite – the size of Forex has now made any other investment market smaller to a great extent.
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