Forex is the market for currency exchange. At a forex booth, you exchange one currency for another. As this exchange can also be seen as a transaction, every forex trade is a simultaneous buy-and-sell decision. But why do you need to exchange currencies in the first place?
PURCHASING POWER IN DIFFERENT COATS
You do this usually as a traveler. Before going on vacation to another country, you decide to get some local currency for your expenses there. You go to a foreign exchange booth for this service. Before traveling back, you’ll go to the same or a different booth to convert what still remains of that reserve back into your domestic currency, as holding a foreign currency is of no practical use back home.
Governments, central banks, and businesses need foreign currencies for intergovernmental, interbank, and inter-business transactions and may keep a good reserve of major currencies. Their motive is similar to that of a traveler visiting another country, though the scale is much bigger.
There is a third class of agents who view foreign currencies as investment opportunities. Known as forex traders, they try to make profits by buying currencies cheap and selling them high. Together with large banks and governments, they make forex the largest financial market in the world. Trust Capital serves forex traders by providing them with trading accounts, trading platforms and guidance.
FACTORS INFLUENCING EXCHANGE RATES
Exchange rates are determined by the demand for and supply of a currency relative to other currencies. A whole host of factors influences these demand and supply conditions, the most important of which are: the rate of inflation in a country, the rate of interest, the status of current account and balance of payments, government debt, terms of trade, political stability and speculation. Anything that affects these variables also influences the relative value (exchange rate) of that currency against others.
This explains the variance in exchange rates from day to day. Lebanese pound’s relative value against the US dollar or euro, for instance, is influenced by all the various factors affecting the Lebanese economy. If LBP/USD returns to an exact previous rate tomorrow, a different mix of the factors will have caused it.
You can think of buying a currency as buying a share in a particular country. Why so? Because just as the price of a stock reflects how confident the market feels about its growth potential, the relative value of a currency reflects the market’s outlook for that economy.
If you believe a currency is undervalued given the growth prospects of its economy, you could buy that currency now, hold it, and make a profit when it gains in value. But apart from this opportunity, there is another in which traders seek to benefit from short-term movements in exchange rates. Such fluctuations probably have no significance in terms of long-term trends. Nonetheless, they present opportunities for skilled traders to make big profits.
Retailers like you, together with other retailers, governments and large banks make forex the largest financial market in the world. Average trading volumes reach 5.3 trillion dollars a day. Retail trading alone accounts for 1.49 trillion dollars of that huge total. Look up the web to see how poorly NYSE compares in terms of trading volumes!
Forex grew to be such a huge market with the advent of the digital age. Thanks to ECNs (electronic communication networks), anyone can now participate in this globally distributed, 24/5 market from almost anywhere in the world.