The Foreign exchange market, also known as the Forex market, is the largest financial market in the world. Daily, approximately $5 trillion exchanges hands in it. The market has many participants including institutions such as banks, hedge funds, pension schemes, large corporations, and retail traders.
The retail traders are the category of participants who have made the market as popular as it is today. Before the advent of retail trading, the Forex market was exclusively a playground of institutional investors. However, the internet and availability of retail Forex brokerage services have made the market open to all.
What exactly is the Forex market all about, you might want to know. The Forex market is the financial marketplace where participants trade currencies. They speculate on the future movements of currency pairs in the hope of making profits. As stated earlier, those participants are diverse ranging from banks, hedge funds, pension funds, large corporations, and retail traders.
How the Forex Market Works
Currencies are important all over the world. Without them, transactions cannot occur — except you want to trade by barter, but we hardly do that anymore. Therefore, currencies make up the backbone of our modern commercial system.
Every country in the world has its currency. The Foreign exchange market exists because people always have a need to exchange the currency of one country for another. For instance, if you live in the UK, most of your local transactions would be denominated in pounds.
Now, imagine you want to go on vacation to the United States. The local yogurt and pizza sellers would want to be paid not in pounds but in dollars. In the United States, your pounds won’t be as valuable as dollars, especially to the locals. This is exactly why you will have to exchange your pounds for dollars.
At the currency desk in the airport, you’re engaging in a Forex transaction. You are buying dollars and selling pounds. Depending on the exchange rate at that point in time, you might get more dollars for your pounds, or less.
The online speculative Forex market essentially works in the same way. The only difference is that apart from your trading capital, you are not holding any money. Also, you are not buying or selling one currency against the other for transaction reasons, but rather for gains.
The Basics of the Speculative Forex Market
Now imagine yourself as a Forex trader in the speculative market. Instead of the currency desk, you have at the airport, you have an online Forex broker. The online Forex broker serves as the intermediary between you and the Forex market. It links buyers and sellers of currencies to ensure smooth transactions between them.
You can trade the GBP/USD currency pair, the pair you traded at the airport, and indeed hundreds of other pairs. All you have to do is to open an account with the broker, fund your account, and speculate on them. However, you need to know that the first currency of every pair, the base currency, is the one in which you do your Forex transactions.
Hence, if it is gaining strength against the second currency in the pair, the quote or counter currency, you buy. Conversely, if it is losing strength, you sell.