What Is Forex? Currency Trading For Beginners

In Summary: 

• “Forex” is shortened from foreign exchange, referring to the global market of currency exchange
• Retail traders can access the forex market anywhere via an internet brokerage

What Is Forex? 

As of 2022, the volume of trading in the forex market exceeds $6 trillion on a daily basis, making it the largest and most liquid in the world. You’ve no doubt engaged with the forex when travelling and exchanging one currency for another, but what exactly does the market involve, and how can you get in on the action?

Forex (also known as FX), is short for foreign exchange, and refers to the trading of international currencies. Essentially, traders buy and sell currencies in pairs, leveraging the exchange rates to generate profits. With 170 different currencies and hundreds of pairings listed on the global market, forex offers traders unparalleled international exposure.

Equities and commodities are traded through regulated exchanges, such as the New York Stock Exchange, which have fixed locations. In contrast, forex is an inter-bank, OTC (over-the-counter) market; a network of institutional parties and banks process the deals so there is no single physical exchange location. And thanks to the internet, traders can access the market anywhere in the world. 

The decentralisation of the forex market also means that it can open 24 hours a day, 5 days a week, unlike equity exchanges. However, each 24 hour period is divided into trading sessions according to which region of the globe is active, meaning that different currencies will be more active, or liquid, at different times. Most commonly, traders consider the four major forex centres in the Sydney session, the Tokyo session, the London session, and the New York session.  

Who Trades Forex? 

As already mentioned, the forex market does not have a centre in one specific location or institution. Nevertheless, there is a general hierarchy of FX players spread across the globe. 

Interbank Market

At the top is the interbank market which comprises direct trading between major banks. On the one hand, you have commercial and investment banks, the big financial players who act as brokers for businesses conducting international trades. For example, if a UK business plans to import goods from the US, it will need to convert pounds into dollars to make payments. Banks act as intermediaries here but also make their own speculative investments for profit. Moreover, if the banks do not deal with each other directly, they do so through major electronic brokerages; Electronic Banking Services (EBS) and Thomas Reuters Dealing are the two competitors in this sphere. 

On the other hand, you have central banks that act on government monetary policies. These banks can influence the strength of their native currencies, for instance, by altering interest rates, or devaluing the currency to encourage exports. 

Medium Financial Institutions And ECN Brokerages

Below the major banks, we find medium to small financial institutions, asset managers, and retail ECN brokerages (like ThorFX). These institutions access the forex market through the commercial banks above them, so their transactions are slightly more expensive than in the interbank level. Hedge fund and other asset management firms will utilize the forex markets to enhance portfolio exposure. 

Retail Traders

At the bottom, we have individual retail traders. These are traders (like yourself), who trade independent of the above institutions. In terms of trading volume, this group contributes the smallest amount. Nonetheless, thanks to online brokerages, accessing the forex market is easier than ever before. 

There are three different ways that these groups trade forex: spot markets, forward markets, and futures markets. The most important to understand is the spot forex market, in which currencies are physically exchanged as the trade is placed. It is actually primarily the major institutions who trade in this way, but brokers like ThorFX offer derivatives trading based on the spot market. 

Why Choose To Trade Forex? 

• Liquidity: It should be evident by now that trading forex puts you centre-stage in the global markets. The sheer size of the market makes it extremely liquid; you can buy and sell with ease, and will not get trapped in the markets.  
• Decentralization: Due to the decentralized exchange, it is also almost impossible for a single institution or central bank to control prices in the long term.  
• Trading hours: In contrast to equity markets, your trading isn’t bound between daily opening and closing bells. From Monday to Friday, the forex market is open 24 hours a day, making it extremely convenient and versatile for traders of all styles and time-zones.   
• Low barriers to entry: Traditionally, brokers would only support high-volume trades and insist that currency traders could put up a large amount of capital upfront. Luckily, forex trading has become more accessible and barriers to entry have fallen. Brokers now offer variable lot sizes and lower deposit requirements to allow traders to hold smaller positions. In addition, traders can utilize a broker’s leverage to amplify their capital’s exposure on the markets. For instance, a deposit of $100 could control $10,000 in the markets with 100:1 leverage! 
• Hedging: this is a form or risk management to deal with market volatility. A hedge position is one that offsets another position, especially where assets tend to move inversely. In effect, the positions are cancelling each other out, and thus reducing the trader’s risk. Forex hedges will frequently offset equities or commodities; for instance, a long position on USD/CAD (US Dollar/Canadian Dollar) could hedge against falling oil prices. 
• Flexibility: Finally, forex offers unique flexibility for traders to handle market volatility. Because traders handle currency pairs, they have the option to go long or short according to the currencies’ relative strengths. 

Summary 

There is no other financial market the spans the globe and penetrates different economies in the same way as forex. Indeed, it’s thrilling that individual retail traders can engage with this international exchange from the comfort of home. Currency trading is unique for its variety and flexibility which make it appealing to traders of all levels. So if you’re ready to get started with trading, check out our next article and prepare for your first trade!