What is Forex ?
Trading in Forex—the foreign currency exchange—is sometimes viewed as pure speculation. The potential for profit and, conversely, loss, are on average higher than in other commodities markets. However, as will be explained below, with Forex trading in general, and iForex in particular, there are means of mitigating potential losses, while maintaining the same opportunity for extremely high profit. The Foreign Exchange is the world’s largest financial market, with over $3 trillion traded daily. By way of comparison, the Forex market is 100 times larger than the New York Stock Exchange, and triple the size of the US Equity and Treasury markets combined. Forex is an over-the-counter market (no central trading arena), meaning that transactions are conducted via telephone or internet by a global, decentralized network of banks, multinational corporations, importers and exporters, brokers and currency traders. This is in contrast to, for example, the NYSE, which is a centralized equities trading location.
Trading on the Forex Market: Basic Concepts
Forex is the buying of one currency and the selling of another concurrently. Typically, the major currencies—the British Pound (GSP), the Euro (EUR), the Japanese Yen (JPY), and the Swiss Franc (CHF)—are traded against the US Dollar (USD). Trade pairs in which the USD is not included are called cross pairs, and occur much less frequently.
The currency pairs are expressed with a base currency as the first part of the pair, followed by the quote currency. (For example, USD/JPY would be the US dollar as the base against the Japanese Yen as the quote.)
Accompanying the currency pair is the quota, or bid/ask price. This is expressed in the following format: EUR/USD: 1.2836 1.2839. The first number in the series represents the bid price, the cost of selling the Euro against the Dollar, or going ‘short' on the Euro. The second number is the ask price, the cost of buying the Euro against the dollar, or going ‘long’ on the Euro. The difference between the bid/ask price is called the pip spread.
A pip is the smallest unit of measure for any currency. In most currencies, this is the fifth digit, or the fourth after the decimal point; in dollars, each pip is equivalent to one-hundredth of a penny. One important exception is the Japanese Yen, in which each pip is the second unit after the decimal point, meaning each pip equals one cent.
Today’s Forex market began to develop in 1973; however, foreign currency trading has been around since Pharaonic Egypt's advent of coinage, and the ancient Babylonian's usage of paper money. More relevant to today’s market however, are the post World War II alterations to the international exchange rate. World War II left the United States an industrial giant unscathed by the war, at least in comparison to the European powers. Worldwide confidence in the dollar made it the reserve currency of choice. To prevent a recurrence of the global depression, the Bretton Woods System, ratified by all the major capitalist countries, pegged international currencies to the dollar, which had its value, in turn, fixed in gold. This led to a system of fixed exchange rates, and the dollar's role as de facto reserve currency was formalized.
This arrangement lasted for the next three decades. In the early seventies, however, deteriorating confidence in the strength of the dollar led to market-driven currency values, and a new system of floating exchange rates took hold. The modern Forex market arose from this new arrangement.
Spot market: The most popular of the Forex trading instruments, the spot market deals exclusively with the current price of a financial instrument. A spot deal consists of a bilateral contract based onan agreed exchange rate to be delivered within two business days. The spot market ischaracterized by a large degree of liquidity and currency fluctuation.
Forward market: Forward trades involve future currency exchanges at a predetermined rate, basedon the interest rate differential between the two relevant currencies.
