Foreign Exchange Basics

This article on foreign exchange basics will look at the forex market. There is a lot to discover about the foreign exchange market and you will need to understand how it works if you plan to take practical steps towards becoming a successful forex trader.

You will come across several different terms for the forex market. Forex and fx are both short ways of saying 'foreign exchange'. It may also be called the currency market, the foreign currency market, the currency trading market, etc. All of these terms refer to the same international market on which the currencies of the world are exchanged and traded.

The forex market is not situated in one particular place. Practically every country is involved so there is a possibility of trading currencies in most countries. Because of this, the market runs 24 hours a day, five days a week. The week starts on Monday morning in Sydney, Australia (that is, 5 pm Sunday EST in the USA) and ends at 4 pm EST on Friday in New York. During that time it is always possible to trade currencies somewhere in the world.

The forex market is a surprisingly recent phenomenon. Up until the 1970s, currencies had been stable relative to one another since the second world war. What was called the 'gold standard' gave every currency a value in relation to the US dollar. This system was introduced in order to maintain a stable world economy.

However, in the early 70s the USA abandoned the gold standard and the values of the different currencies began to change. Banks immediately began to exchange currencies for profit, buying low and selling high, instead of only making exchanges when they needed to transfer money from one country to another. In effect, each currency became a tradeable commodity. This was the beginning of forex trading.

The value of a currency is, in a sense, the value of the nation whose currency it is, so just like companies on the stock exchange, if a nation is successful the value of its currency increases and if it is going though a crisis the value drops. These fluctuations can be great and can happen very fast. The sums involved can be huge too. The total value of transactions on the forex market now averages almost $2 trillion dollars a day.

The market is still dominated by international and investment banks, major corporations and other large financial institutions. However, it is possible to trade as a private individual through a broker and with the rise of the internet this has become much more popular. There are now a large number of people involved in forex trading through their home computers, although because they trade much smaller amounts than the institutions, they only account for around 2% of the total forex market.

The most common exchanges involve the US dollar against other currencies (especially the euro, British pound, Japanese yen, Swiss franc and Australian dollar) but it is possible to trade any one currency against another. Many of the automated forex robots used by individual traders concentrate on lesser pairs such as the pound against the euro.

The foreign exchange market is huge and an individual trader can feel like a tiny ant dodging around the feet of elephants. But anyone can get into it if they have a little capital that they are willing to risk. Some brokers will let you start with as little as $250. Before investing any real money, however, it is best to practice with a forex demo account while you learn the foreign exchange basics.