Briefly about Forex

Forex («FX», or Foreign Exchange market) is an over-the-counter currency market which trades in currencies of various countries (exchange rates). The forex market is unique in terms of trading volume, liquidity, and the large number of factors which can affect market conditions. The forex market is geographically dispersed, with no unified market or central clearing venue. It comprises a huge quantity of buyers and sellers, the key ones being commercial banks, investment funds, financial companies, and governments.

Due to the development of margin trading and innovations in telecommunications (especially the Internet), individuals are now able to profit from exchange rate movements between different currencies. The main concept of margin trading is actually rather simple: the fundamental point is that, using leverage, you can trade amounts that greatly exceed your existing funds. For example, to make a transaction for EUR 100,000, a trader does not need to have that amount on his or her account. Depending on the degree of leverage, it is enough to use a sum which amounts to only 0.5% of the transaction figure.

Margin trading can be exemplified thus:

In the Forex market, trading is conducted on the difference between a ‘pair’ of currencies. Currency pair quotes show how much secondary currency can be bought or sold for base currency. Base currency is the first named currency in a pair. For example, in the currency pair EUR/USD, the base currency is euro. Currency pairs are traded in ‘standard lots’ which generally total 100,000 units of base currency. There are also so-called ‘mini lots’ that make up 10,000 units. To buy one lot per pair EUR/USD, taking into account a market quote of 1.5000, will require only EUR 1,500 or USD 2,250, although the total transaction amount is as high as EUR 100,000.

It should also be stressed that you can make a profit on both the rise and fall of currency rates. In forex it is common for beginner traders to wonder how it is possible to sell euro if there are only US dollars on your account. The answer is that, in making a transaction to sell the currency pair EUR/USD, a trader does not actually conduct a sale but rather, according to the principles of ‘margin’ and ‘full netting’, speculates on a fall in the rate of this currency pair. In order to carry out such a deal, you require an amount of collateral which is determined by the extent of leverage. Instead of an actual exchange of one currency for another, an opposite transaction to the initial (position closing) one occurs, after allowing for profit or loss from the first transaction. The other key concept of margin trading is the obligation to conduct a counter transaction. This procedure is not limited in time, and a trader can conduct such a transaction the same day or even several years later.

One advantage unique to the Forex market is that it operates on a 24-hour basis, with no intervals or stops, and does not cease operating in the event of extreme volatility, as, for example, is the case with stock exchanges and commodity markets.

According to the organizational basis financial markets are divided into organized (stock-exchange) and unorganized (over-the-counter). In the first case, trade is conducted through the stock exchange, which has a specific geographic "residence", working time, its own rules, standards and specifications. In the second case, the market does not have a specific "address", trade is conducted every second around the world.

Forex falls exactly into the second category. This is the over-the-counter market (another name is OTC market).

The main participants of the forex market are:

  • forex brokers
  • commercial banks
  • central banks
  • exporting companies and importing companies
  • funds ( investment, hedge, pension)
  • stock-exchanges
  • private individuals

Besides the fact that commercial banks are amongst the main participants of foreign exchange currency transactions and make transactions at their own expense, other market participants keep their accounts at commercial banks and give forex rates to the banks to conduct similar transactions.

Thus, the Forex market is the de facto market of interbank transactions. The main participant of this market is the forex broker