Forex, often abbreviated as FX, is a combination of the words “foreign” and “exchange.” Very simply, it is the international market on which all the world’s currencies are traded.
What is Forex?
Why Is There a Need for Foreign Currency?
Most foreign trade is conducted in U.S. dollars, euro, the pound sterling, Japanese yen, and, to a lesser extent Swiss francs and Canadian and Australian dollars. Because of that, most forex trading is conducted in their respective financial centers: New York, Frankfurt, London and Paris, Tokyo, Zurich, Toronto, and Sydney. Unlike stock exchanges, the forex trading is conducted 24/7. It never stops because there is always a need to exchange currency around the clock in a global economy.
When a transaction is made between two parties in different countries, they have to agree in advance which currencies to use. Since there is comparatively little demand for currencies of small countries in other small countries, the simplest solution is to settle on using one of the world’s major currencies cited above.
Why Do Exchange Rates Change and What Happens When They Do?
In the short run, the daily demand for all currencies fluctuates daily in response to the number of transactions that require them, and this affects their comparative value. In the long run, the full range of other economic indicators comes into play as well, including national interest rates, inflation rates, the balance of payments (the value of exports minus imports), taxation policies, and budget deficits versus surpluses.
Ultimately, any currency’s attractiveness in the forex market affects its value as well. The more it is in demand the more it can be relied upon as a means to buy and sell goods around the world. In such a case, it is called a “strong” currency. This generally generates a rush to acquire more of it as a hedge against “weak” currencies that can decline in value. When that happens, the cost of imported goods drops in the country whose currency is strong.
That can certainly be popular in a country that has to import all its cars and oil, but if it quickly leads to a spending spree, then it brings with it the risk of inflation. A rise in the inflation rate means that the value of the currency declines, which in turn would lead to a reduction in its demand abroad.
In addition, because its own citizens are paid in the local strong currency, the cost of the goods and services they produce become expensive abroad, which means its exports can suffer. That, in turn, can lead to a rise in unemployment as orders for those goods and services abroad are reduced. The interdependency between all these factors is a challenge for economists charged with steering a country’s financial health.
There is always a possibility that unexpected factors can suddenly impact currency trading as well. Among them are sudden, unexpected weather conditions such as hurricanes and typhoons, natural disasters such as floods and earthquakes, strikes declared by labor unions, and, of course, wars. On the other end of the spectrum, of course, are also felicitous factors that can provide an immediate stimulus to an economy, such as the discovery of new oil and gas reserves, foreign investment, a major unexpected upturn in tourism, or the signing of a treaty that ends a conflict with a neighbor.
Forex is relatively easy to understand. Anyone who has ever visited a country overseas has already participated in the forex market simply by exchanging his or her own currency. The jump from there to becoming a participant in the global forex market is indeed a small one.
Trading forex online is a user-friendly process for the simple reason that anyone can participate, anytime and anywhere. The obvious benefit of online forex trading is that you don’t have to travel to Tokyo to buy or sell yen or contact someone who’s there.
The market also includes index trading and CFD trading tied to the value of a foreign currency or currencies.