What is Foreign Exchange and Forex Trading?

I’m sure that you have heard a million times those two words Forex Market, you might have mixed associations what a Forex is, thanks to the Medias … so do you want to understand what a Forex Market really is? You may be watched banners on countless websites claiming that the forex is the “money machine”, all from the comfort of your bed. This sounds like the best thing you can do, sounds like the ultimate dream, yeah right? Forex trading is like any business and profession so it would take you lots of devotion to learn the skills – it’s like any other profession. You can’t snap your fingers and to be a self-made millionaire just by trading forex, you need to have a huge arsenal of skills that could take you months or more realistically years to master…

After this brief introduction, if you still want to learn what a Forex is please proceed reading. I’ve created for you a “mini” course, where I will reveal to you basics of forex trading in both informative and non-boring fashion.

What is Forex?

what is forex moneyForex or FX stands for “foreign exchange” market – basically on the forex you can exchange or trade one currency for another. You may book a two week holiday in a foreign country or to purchase something on Amazon from overseas or some other interaction with foreign counterparty, so in order to finalize the transaction you need exchange your currency on the foreign market. If you had at least one transaction, that wasn’t in your national currency, then you call yourself a “trader”, you made at least one trade on the Forex. Good for you!

Forex Market is the “playground” of all banks, business, governments, investors and traders – they get together on the market with on goal to make the price of certain market. In the process of doing so they exchange, invest or speculate with huge amount of money. Daily on Forex all market participant in the world exchange an average of $5 trillion, making it the largest and most liquid market in the world.

You need to under that Forex market is not like an ordinary central marketplace such as NYSE, Forex is trading through the help of electronically networks, this means that there is not a single central point and all is traded electronically “over-the-counter”. NYSE is centralized exchange and all transactions are done through the help of specialists and dealers that are member of the exchange. As I told you Forex is OTC, which means that trading is conducted between computer networks around the world – this means that forex is open 24 hours a day, 5 days in a week so if there is nothing that you can do, so can stay in front of your PC and watch how price move all day long. On of the largest financial centers are London, New York, Tokyo, Zurich, Frankfurt, Hong Kong, Singapore, Paris and Sydney.

Short recap on Forex history

bith of forexYou all know that gold was considered as money back in history and this formed was called a gold standard. This standard was unlinked after the end of World War II, one of the main reasons for this action was that most of European countries depleted their gold reserves to support their war machines. Most of gold was repatriated to US so after the end of the war, western countries decided to fix their national currency to the dollar and the dollar was linked to gold. The dollar was transform to a reserve currency for all currencies and the dollar was backed by gold – this reserve backing system was known as the ‘Bretton Woods System’.

In 1971 the U.S. declared that it could no longer exchange gold for U.S. dollars that have been held in foreign reserves, this designated the end of the Bretton Woods System. It absolutely was this breakdown with the Bretton Woods System that eventually resulted in the mostly global acceptance of floating foreign exchange rates in 1976. This became effectively the “birth” of the current forex exchange market, even though it didn’t turn out to be widely digitally traded until about the mid-1990s.

Who are the players in Forex?

It’s very strange for me when I talk with traders that haven’t truly know the hierarchy or structure of forex player and what part we retail trader really take in the market – guys we’re retail traders we are so insignificant in comparison of big market movers. I will show you in deep the structure of participants I want understand the structure, this will helps you to grasp why Forex market moves and why.

forex playersBanks – Banking industry allows both a commercial transactions and provide huge amount of speculative trading each day. Currently great share of banks’ profits come from facilitating transaction for traders and through speculative trading. If you want to make a transaction by another trader you need a medium to make the transaction so here a banking sector comes. Many times bank is called a “dealer” they facilitate clients trades. Big banks also are known as market makers – a market maker always is prepared to buy or to sell financial instruments in order to provide liquidity on the market, by this process they set the bid-ask spread for their instruments. Banks make money also as a regular trade through speculating, this is done by their proprietary trader who are trading for the bank’s own account.

Companies – Companies need to use the foreign currency market to pay for goods and services from foreign countries and also to sell goods or services in foreign countries. An important part of the daily Foreign exchange market action originates from companies seeking to exchange currency to be able to transact in other countries. Also companies can use Forex in order to protect form currency rates changes by purchasing special contracts.

Governments and Central Banks – The ultimate players on the Forex market are Central Banks – they have the monopoly of a monetary policy so they can do practically everything in regards money supply. Central banks can set interbank rates and interest rates in order to control the inflation and currency rates. Central banks could intervene to make their currencies appreciate or depreciate. For instance, a central bank may weaken its very own currency by creating more from the currency, which can then be employed to purchase foreign currency. By doing this the central bank effectively weakens the domestic currency hence making exports more competitive in the global market. Central bank is considered to be the mother of all commercial banks in a country. Every decision from Central Bank can make huge impact on the Forex market.

Hedge Fund – You need to know that more than 80% of all transaction that were made in Forex market was speculative in nature. Speculation occurs when a person/institution try to make profit from the change of a particular financial instrument – the game plan here is not to own that instrument but to make profit by appreciation or depreciation. Trading is speculative in nature and the big dogs in this business are hedge funds. Their solely goal is to make money while speculation, the only difference between retail traders and them is the quality of money – those guys have tens of billions of dollars at their disposal.

Institutional Investors – Do you know what happens with your 401k money or with your insurance premiums or the money from your mutual fund? All of the money goes to the exchanges. These are special types of investing firms that are heavily regulated by the government because they operate with nation’s money – these firms manage large portfolios of clients’ money. Yes huge part goes to equity markets but they could be invested in overseas, so in order to do this an institutional investor must take a step in the Forex market. Firm may have an oversea portfolio of foreign securities so in order to buy or sell more it need to make an order on the Forex market.

equity investorsEquity firms & Private Investors – This type of investors are pretty much the same as institutional but with one main difference, they use their own money. Jim Rogers, Warren Buffet, George Soros and so use their money to buy assets overseas or to speculate directly on Forex market like George Soros.

Retail Forex Trades – Well we come to the bottom of the forex hierarchy, where you and I come. Mainly all retail traders trade with their own money and our pooled money are fraction in comparison of big players. Retail trading is one of the fast growing industries in financial sector, thanks to Forex trading platform and their ease of accessibility on the internet. There are two primary types of retail Forex brokers that provide us with the ability to speculate to the currency market: brokers and dealers. Brokers act as an agent for the trader by trying to find the best price in the market and executing with respect to the consumer. With this, they charge a commission into the price obtained in the market. Dealers are also called market makers simply because they ‘make the market’ for that trader and act as the counter-party to their transactions, they quote a price they’re prepared to deal at and are compensated through the spread, which is distinction between the buy and sell price.

Advantages of Trading the Forex Market:

  • forex advantages The most liquid and largest market in the world, with daily more than $5 trillion per day. This means that there always will be someone who will buys or sells your currency pair.
  •  You can trade whenever you want from wherever you want – you can trade in your bed 2 am and you can enter or exit.
  •  Ultra low entry cost – Forex trading is the cheapest business ever. You can fund your trading account with little as $100 and still make profitable traders. You need to have laptop and internet and there is nothing more to ask for forex trading.
  •  You can make a good trading portfolio with just major currency pairs and specialize in them.
  •  You can trade Forex intraday or swing thanks to volatility. Traders can profit in any market condition and provides for high-probability weekly trading opportunities.

May be one of the best thing with Forex and Forex Trading is that you don’t need to have a fancy degree from a colleague or university – you don’t need to be a MBA to succeed in Forex as a matter of fact you don’t need any specific qualification. You even don’t need to read tons of global financial news or to run CNBC, CNN and so on you TV or to have a subscription to latest economic data. The only thing you need to have is an intellect, but not this kind of intellect of Mensa – if you have IQ of 160 or above 100 you can still be a successful on the Forex market. Trading on Forex requires huge arsenal of skills and you might find it surprising but successful trading is linked with psychology and discipline. Your worst enemy on the market is just yourself – your emotions and mentality, so you need to have in mind that trading is one biggest psychological challenge that you will ever face in your life.

In order to be a successful on Forex you need to an emotional journey deep in your emotions. You need to control your emotions, a successful trader has cool, calm & collected attitude with his/her emotions. Failure rate on Forex is one of the highest in all business and more than 90% of traders lose their money – some got with small or bigger lost and other even go bankrupt. This harsh statistic is based mostly on the lack of emotional control, traders failed to overcome their emotions.

risk profit forexIs Forex Trading a get rich quick scheme? Absolutely not! This is wrong mentality – it’s like going to Vegas for a weekend with 10k and to be a millionaire by the end of the weekend. As I said emotions are the main driver of failure in addition to emotions I can add wrong expectations and bad attitude. Many traders were wiped out just because they think Forex is like any other casino. In order to be successful you need to control your emotions, to have a positive risk to reward ratio and perfect money management. It’s like in poker there are amateurs and professionals – the difference between them is the control. By controlling the risk and money professionals can preserve their capital to achieve consistency and in the long term to make huge profits.

For all of you beginners I can’t stress more than enough that Forex trading is very risky place to be in – there is very thin lane between profit and loss. This is not get rich scheme or a casino you must not focus on how much money you can make, you need to focus on the risk and capital preservation. If you still want to trade on Forex market you need to know that all the time we’re trading the odds and can make or lose money at any given trade you take.

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