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Forex market is the world’s largest financial market, where millions of transactions take place everyday. Today all types of investors, whether big institution or individual trader can easily start profitable forex trading. Nevertheless, the important point to understand is that beginners in fx trading must have a forex active account, which is provided by forex trading broker, to start forex trading. Besides this, today many forex brokers offer forex demo account so that the beginners can also virtually learn the basic functionality of a real fx account. The forex demo or practice account holder can virtually deposit money in his or her account and may even enjoy forex trading without any fear of financial losses. With the help virtual money of domo account he or she can also buy and sell foreign currencies. Therefore before starting a trading in fx market it is advisable to open forex demo account to get the real experience in forex market and test your trading skills without any risk. When you gain the sufficient experience about fx trading through forex demo account, you may open a live trading account and do actual forex trading.

Forex is a loose acronym for Foreign Exchange Market that originated in the 1970s around the time free currency exchange rates were introduced in the world. In forex markets, market participants determine the price of one currency against the other purely from market forces stemming from supply and demand. There are no external controls in a forex market and is perhaps the best example of a perfect market with free competition. Forex is also the biggest liquid financial market in the world, with market volumes ranging in 1-3 trillion US Dollars a day.

The US Dollar, Euro, Japanese Yen, British Pound and Swiss Francs are the major currencies traded in forex markets.

Little Bit Of History

The foreign exchange markets as we see today have evolved through the gold exchange period, followed by the Bretton Woods Agreement, to its current setting. Although by 1973, the major industrialized nations' currencies were floated more freely across nations, coinciding with currency prices being quoted daily, it was only due to the advent of computers and technology in the 1980s that the market reaches for cross-border forex trading gained momentum extending through Asian, European and American time zones. Gradually over the years foreign exchange transactions increased intensively to all the facets we see today in forex markets worldwide.

Today advances in computer technology have permitted the instantaneous transmission and receipt of currency prices across the world. These technological advances in computer networks are the primary reason behind the growth of forex trading amongst ordinary investors.

How Does Forex Market Works?

To understand how forex markets work, one has to understand what exactly constitutes the forex market, the institutional framework that drives this market, and importantly the process of currency price determination.

Foreign exchange market is no different from any other market where buyers and sellers meet to buy or sell a commodity for a specific price. The only difference in forex markets being, it is the “currency” that constitutes the commodity, and the price at which it is exchanged conforms to the foreign exchange rate for that currency at that point in time.

Export earnings of corporations, overseas remittances, and investment flows (direct or borrowed capital) constitute the main sources of foreign exchange. Individuals and entities who receive foreign currency are the primary market suppliers and they may sell foreign currency to licensed exchange dealers who in turn may pass it to other dealers in need of foreign exchange. The Central banks may sell foreign reserves to make market adjustments, and on the other side companies would need to buy this foreign exchange to make overseas payments. This creates a market for foreign exchange wherein a person may sell a currency today and probably emerge as a buyer the very next day.

Forex Market Framework

The biggest foreign exchange markets are in Tokyo, London and New York and they are networked with each other using modern technology creating a seamless interface that transacts currency prices and deals almost instantaneously across the world. The institutional framework that drives the forex markets is perhaps the key to the market itself and comprises the following:

• Commercial and Central banks in different countries
• Exchange markets and firms that conduct foreign exchange deals
• Investment funds
• Brokerages and individuals

By transacting with different clients in exchange conversions, commercial banks accumulate a great chunk of forex market needs and are often shared with other banks in interbank dealings. These banks (Union Bank of Switzerland, Swiss Bank Corporation, Deutesche Bank, and Citibank) with daily volume of transactions in billions of dollars greatly influence forex markets. Central Banks as for example the US Federal Reserve influence forex markets by regulating the investment climate and making market interventions and so on.

Exchange Rate

Exchange rate is a market-determined phenomenon. In other words, the exchange rate depends on supply and demand conditions in the market for any particular currency. A currency exchange rate is derived from the ‘spot transactions’ (means foreign exchange trades that are initiated and settled within two business days with the respective exchange) of authorized dealers with the public.

This exchange rate that is reported in the price tickers that you see on your trading screen reflect the cumulative transactions undertaken by the major market makers (namely the institutions) with large value transactions reflecting more on the currency prices than a small value transaction. That’s probably one of the reasons why currency prices keep changing on your screen reflecting the rate at which the major market maker’s i.e. the institutions trade.

Advantages of Forex Over Other Markets

The Forex market offers many advantages, over stock market trading and other forms of investment opportunity. In forex markets financial reasons compel the execution of a forex deal and not commercial considerations. Also as compared to stock markets, exchange markets do not operate out of any specific building.

In forex it is not obligatory to buy a currency to sell it later but it is enough to open buy/sell position for any currency without actually possessing it, unlike stock trading where you are committed to have the full face value of the stock before you can trade for that amount of stock.

Although Forex markets can be volatile at times, it offers an advantage over a declining stock market, in that with proper knowledge of forex markets you could still key into profitable trades. On the contrary, people tend to avoid stock markets when it is in a downward spiral as no one really knows when it would start on an upward trend. In other words forex trades can be made even if the markets were rising or falling.

The profits you could possibly make in stock markets pales into insignificance in comparison to the windfall profits you could be making in forex markets. For example proper leverage alone can make you huge sums in a very short time and that too by making fewer trades.

The limited number of currencies traded in forex markets makes it easier to monitor market trends that relate to those currencies, whereas in the stock market a lot of factors could affect individual stocks, not to mention the innumerable number of stocks (there are several thousand stocks registered in most stock exchanges) that would have to be monitored at any given point in time.

Although it has its own trends and cycles punctuated by high volatility, forex markets don’t fit into the traditional Bull/ Bear market cycle typical of stock trading. That is because currency rates always throw in new intriguing ways of making profit. For example, interest rates do not adversely affect currency markets as it would stock market indices and stocks in general. When interest rates go up, that country’s currency gets strengthened (giving profitable opportunities to the discerning trader) whereas it would depress stock markets in that country and probably cause losses to a stock trader having several open positions.

Comparison of size and liquidity, and market time

It is impossible to quantify the exact amount of money traded in forex markets worldwide since trading is not restricted to one single exchange or location. But several estimates put it between 1-3 trillion US Dollars a day. This is certainly lesser than the volume of stocks traded in all the major stock exchanges around the world and also far less than the gold and forex reserves of the developed world. It also far exceeds the daily volume of foreign trade transactions between different countries. Therefore in terms of size, number of participants and liquidity, forex markets are huge and offer the best opportunities to the investor.

This superior liquidity in forex markets allows traders to open and close positions in a matter of a few seconds or keep that position going on for several years or perhaps indefinitely which is not possible while trading stocks.

Using networked computers, forex trading offers you a world wide market, instantaneously available to you on 24/5 basis from 00:00 GMT on Monday to 10.30 GMT on Friday covering all time zones. When the sun sets in one trading center, it is dawn and the beginning of a trading day somewhere else in the world. On the contrary, stock market in any major country opens at 10 am local time and remains operative till 4p.m local time restricting the possibility of indulging in round the clock trading.

Forex trading is done strictly on your calling. Since forex trading goes on 24 hours a day there is no need to have a fixed schedule, and even if you set one, it’s purely your discretion based on your own trading strategy and of course to your liking.

Currency pairs are financial instruments traded in forex markets. Every pair of currency traded in the forex market is considered as an individual product (or financial instrument). A set of two currencies always constitute a currency pair, of which one currency is being bought by the other. The buying and selling of currencies from around the world constitute currency trading.

Currency Symbol

Each currency has its own symbol as for example:

For the Euro, it is EUR
For the Japanese, it is JPY
For the Pounds Sterling, it is GBP
For the Swiss Franc, it is CHF.

XXX/YYY is the general format by which currency pairs are denoted, where XXX and YYY both refer to the ISO 4217 international three-letter code of international currencies. Currencies are always traded in pairs, and here are a few examples of currency pairs:

For Euro-Dollar pair, it would be EUR/USD
For Pound Sterling-Dollar pair, it would be GBP/USD
For US Dollar-Canadian Dollar, it would be USD/CAD
For Australian dollar-US dollar, it would be AUD/USD

For Dollar-Swiss Franc pair it would be USD/CHF and so on for other currency pairs according to their three-letter currency codes. 80% of all trades in the Forex market originate from these currency pairs.

Consider this example of a currency pair GBP/USD. In this example of a currency pair, the currency on the left (GBP in this case) is called the base currency. The currency on the right (USD in this case) is called the quote currency (also called counter currency).The base currency (in this case GBP) always has a value of 1 in exchange rate.

In the currency pair GBP/USD, GBP is being bought, and the value of the currency on the right (USD in this case) represents how much of the base currency it is worth.

Consider another example of a currency pair EUR/USD 1.2436. This simply means 1 Euro is equal to 1.2436 US Dollars. Or it means that 1.2436 US dollars are needed to get one EUR. If you want to buy 100 Euros how much would you need in USD? You need precisely 124.36 US Dollars to buy 100 Euros.

Generally you will see the USD quoted first in most currency pairs the exceptions being Pounds Sterling, Euro- Dollar, Australian Dollar and New Zealand Dollar. The predominance of the US Dollar and the fact that it figures in a majority of forex transactions is perhaps a legacy of the Bretton Woods Agreement (1944), which pegged all currencies to the U.S. dollar.

“Bid” and “Ask” prices

All currency pair quotes have a bid and ask price. For example the currency quote for EUR/USD would appear as EUR/USD 1.4888/1.4890. The figure on the left, i.e. the number 1.4888 is called the “bid” price. This means you can sell 1 Euro for $1.4888

The number on the right of the currency quote EUR/USD 1.4888/1.4890, i.e. 1.4890 is called the “ask” price. This means you can buy 1 Euro for $1.4890. It is important to remember that the “bid” price is always lower than the “ask” price.

Spread

As we have seen from example cited above, every currency pair has a "bid" and "ask" price, and further the “bid” price is always lower than the “ask” price. The difference between the “bid” and “ask” price is called the “spread”.

In the currency example EURUSD 1.4888/1.4890 you will notice that there is a difference between the “bid” and the “ask” price. This difference is called as the spread. In other words, the “spread” is the difference between the highest price the buyer is willing to buy the currency and the lowest price the seller is willing to set it. For instance if you assume the “bid” price is $1 and the “ask” price is $1.3 then the spread would be $0.3.

In the example of currency quote EUR/USD 1.4888/1.4890 we discussed earlier, you will notice that the spread is 2 pips being the difference between the ask price and the bid price (1.4890 minus 1.4888). “Spreads” are usually on the lower side in forex markets on account of high liquidity

What is a pip?

Pip, is an acronym for Price Interest Point, and represents the smallest digit in the price of a currency. Pip is also the method by which profit is calculated in a currency deal, and its value depends on the base currency of the pair. Consider this example. A move in the EUR/USD from 1.4877 to 1.4897 equals 20 pips. And a move in the USD/JPY from 89.70 to 89.90 equals 20 pips.

When your trading account is in US Dollars and the U.S. dollar is the base currency, then one pip equals one dollar in a mini account or ten dollars in a standard account. So if you place a trade with one of these currencies and earn 20 pips it would translate to a profit of $20 in a mini account or $200 in a standard one.

If the base currency is not the U.S. dollar, then the value of one pip is equal to one unit of the base currency. For example in the GBP/USD, the pound sterling is the base currency, so one pip is equal to one pound; So if you make 20 pip profits in GBP/USD it would mean a profit of 20 pounds Sterling in a mini account. When you make profits in these currencies, you’re making them in the base currency, which then may be exchanged into the U.S. dollar at the current exchange rate, since your trading account may not be denominated in the base currency.

Summing up, in this article we have learnt what a currency pair is, and what is meant by “bid” and “ask” prices, spread and pip.

This fascinating market, where buying or selling the currency of a country against another, is called forex. With a staggering US$3.5 Trillion traded per day, this makes the forex market the biggest existing financial market to date. No other market compares to the currency market and its volatility.

Hundreds of thousands even millions of dollars are made every-day by major financial institutions dealing in the foreign exchange market. They are referred to as the movers and shakers of the currency market. Those corporations deal in millions of dollars at any given time thus causing a stir in the market. If you are not already slightly familiar with the currency quotes, you should know that the value of a currency pair goes through drastic changes every single day. These fluctuations in price allow for major profit and also may result in losses.

What makes the Forex market even more appealing than the stock and futures market is the fact that it is a 24-hour market which is opened nearly 7 days a week. Trading opens in Sydney, Australia on Monday morning. Then the Tokyo market opens followed by the European market. One hour after the open of the European market the London market becomes active. The UK market is considered to be one of the largest and most active markets in the currency world. Finally we reach the New York market, which is the last market to open each day.

EUR/USD, GBP/USD, USD/CHF and USD/JPY are referred to as the major pairs as they are backed by strong political and economical back-grounds. These pairs are the most traded ones on the currency market. Next on the list are the YEN pairs namely GBP/JPY and EUR/JPY and the commodity pairs AUD/USD, NZD/USD and USD/CAD.

My first insight in the world of trading begun when I was still at university, I was quite confused to how this process actually worked. However after some readings, it all made sense. You see, apart from using money to acquire goods and services, the same money could be use to buy or sell another currency in some other countries.

Currency trading which is the buying or selling of a country’s currency against the currency of another country is effectuated by Forex traders. They are basically speculators who take advantage of fluctuations in currency quotes to make money. If they believe a currency will appreciate they are more than likely to buy this particular currency in the hope that they will make some profit when comes the time to sell. Traders with a good knowledge of the market make a great living trading forex.

Getting involved in the forex market nowadays has never been easier. Though you will need some understanding of the market, it is still easy to get your feet wet and experience firsthand, how the dealing process works.
Here is what you will need before starting:

- PC
- Internet facility
- Some money as start-up capital
- A reliable broker

That’s it, simple and sweet!

Well, it is very easy to get started however, if you want to succeed in this market, education is crucial. Without a solid proven educational program you may well take quite a while before being successful.

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