The finance world is filled with a lot of jargon and loose terminology. It's not the easiest thing in the world to understand, but if you break it down into its most minor parts, you'll be able to make your way through it. If you want to be successful in this industry, one of the first things you need to learn about is what forex is – and why it's so important.
Typically, when you hear the word "forex", you think of currency trading – and that's an excellent thing. The reason is that forex is the most versatile of all trades. In fact, as a small business owner and entrepreneur, you may be trading in several different currencies every day. After all, there are only 24 major currencies – and they have to exist within the context of the global economy.
This means that we're always in need of forex. For example, let's say that you buy a TV from Best Buy and pay for it by credit card. You then go out and buy yourself a $1,000 television to put in your office. You have more money in your account than the amount of money required to make the purchase – so you go and deposit the rest of it into your bank account.
Because you paid for the TV through credit, Best Buy owes you an amount of money on your end. That payment is going to be made in pounds. The only way for Best Buy to get that money into your bank is by discussing it with their international affiliates and exchanging it into dollars. They're going to charge you a fee for that, but most companies accept the fact that forex trading is part of doing business these days.
More than one billion people trade on forex every day – and even if you're buying and selling the standard currencies, there are a lot of reasons why you should be getting involved as well. Forex has such a high daily trading volume because it is the most versatile of all trades. In fact, as a small business owner and entrepreneur, you may be trading in several different currencies every day.
Governmental authorities and large investment banks are significant players in the forex market. At the same time, central banks are directly involved too. In particular, large institutions can make big trades as a result of their resources and financial clout. Forex trading is an integral part of the foreign exchange market. Banks and other large financial institutions use forex to manage their vast assets. The exchange rate is a proportion between two currencies denominated in different currencies. Governments can intervene in the market just like any other investor.
Individuals are also able to trade in forex on their own. This is part of what makes forex so popular worldwide – especially on the Internet, where you can trade from your home computer or mobile device.
Direct participants, including banks, governments, dealers, and broker companies. These institutions invest in foreign exchange with their cash and make trades directly with each other or with other customers.
Indirect participants, including households and companies. For these customers, a bank acts as a middleman between them and the market. Indirect participants typically cannot purchase or sell currency themselves (or at least not in large quantities) and must rely on a broker to do this for them. The bank might also hedge the risk of exchange rate movements by going short or long on its own account.
The foreign exchange market is one of the largest financial markets in the world, with more than $1.5 trillion traded daily. Large banks may trade hundreds of millions of dollars per second, but individual traders can sometimes trade as little as $1 – or even less – at any time.
Investment banks use forex trading to raise capital and convert their holdings of one currency into another. They're also able to use it as a source of income. The main reason why investment banks use forex is to generate revenue. Investment banks also act as counterparties when investment banks or other direct participants transact directly with each other.
Governments use forex to manage their foreign exchange reserves. This is why the US government, for example, auctions off the right to purchase euros from its treasury department.
Banks use forex to manage their assets and transactions. Banks can hedge certain risks in transactions by going long or short on the exchange rate. They also unload disproportionate assets, such as at the end of the financial year or before a big merger. Banks also use forex to earn interest on funds deposited with them (banks typically charge an administration fee on this amount).
Central banks use forex to help maintain the value of their country's currency. They end up doing it both with other central banks and on their own. Central banks also use forex to control inflation and protect currencies against wild fluctuations in exchange rates.
Overseas investors use forex as a way to diversify their assets across the world. Some cheaper assets are available in other countries, such as real estate or stocks in those countries. The advantage of investing in other countries is diversifying away from volatile areas, such as commodities or emerging markets. This is especially valuable for those who see a collapse in specific markets or currency values – they can shift out of it.
Many actors all play their part in creating this high daily trading volume, and it is difficult to calculate precisely how much of the total volume is traded. The money which is traded daily is not only money in the bank or deposits but also sales on credit.
Foreign exchange markets are growing more extensive and more prominent across the globe. With the ease of electronic trading platforms, instruments such as CFD's, futures and options have become more prominent in recent years. These platforms have helped make trading less risky for both the investor and broker as they allow traders to take their chances with a small amount of capital while focusing on their trading strategy more than their margin requirements.
It is difficult to calculate the size of the Forex market, as many prominent players trade without reporting.
The Forex market is full of both institutional and retail investors. The main reason for investing in foreign exchange is diversifying away from volatile areas, such as commodities or emerging markets. These markets are growing more extensive and more prominent globally with the ease of electronic trading platforms, instruments such as CFD's, futures and options have become more prominent in recent years. Forex is traded so much because it facilitates national and international trade between various parties such as central banks, investment banks, consumers and even governments. This interplay causes market fluctuations in the currency markets.
Over $1.5 Trillion is traded daily in the foreign exchange markets