What is trading FOREX (Foreign Exchange)?
Forex plays an important role in global financial markets. With a turnover of 5 billion dollars a day, the foreign exchange market is the largest financial market of all. But what is change? Generally speaking, foreign exchange is a foreign currency. For example, if investors want to buy US government bonds, they must first exchange euros for US dollars. But the currencies themselves can also be exchanged. The following guide serves as an introduction to the subject and explains the important mechanics of forex trading.
What is trading: The history of forex
We are not going to go through the complete history of the money market or currencies in this article. Many of you no doubt have a hands-on mentality and want to dive straight into the interesting aspects of the forex world. In order to get an idea of the story, the most important events are listed below.
The first coins came into circulation around 1000 BC. AD and have been found in distant China. These coins were mainly made of all kinds of metals such as copper, lead and iron. Often they also had hollow interiors so that they could be easily bundled on a stick or with a rope.
The gold standard was introduced around 1880. Participating countries agreed to link the value of their currency to a value in gold. This situation was no longer tenable with the outbreak of the First World War and the US dollar became the main currency of international trade. To date, the US dollar is considered the most important currency. The system could not last, because the governments needed a lot of money to finance war and reconstruction.
Bretton Woods is central to the creation of the International Monetary Fund and the World Bank. It is a cooperation agreement between 44 participating countries. A fixed exchange rate has been determined between the different currencies. However, small fluctuations of around one percent were allowed. The Bretton Woods agreement was completely dissolved in 1971.
Indeed, the Treaty of Rome of 1958 decided to optimize the economic activity of the surrounding countries. The ambition was to build a “union” across countries. All of this resulted in the European Union as we know it today.
What is Forex Trading?
What is trading? Even small investors can trade currencies. However, it is extremely rare that a foreign currency is actually acquired physically. On the contrary, in forex trading, the right to a particular currency is purchased, but the currencies do not physically change hands. Forex trading is done through so-called financial derivatives. Options in particular are used here. In simple terms, the value of these derivative financial instruments changes according to the value of the currency pair in question. Financial products only simplify forex trading, since currencies do not have to be physically transferred. Many of these financial derivatives have a leverage. This allows traders to move more money through the financial markets than they actually actively use. This is partly done through normal online brokers, but there are also FOREX brokers that specialize in FOREX trading.
It seems confusing at first glance, but forex trading is quickly explained with the help of a small practical example:
A currency trader anticipates an appreciation of the dollar against the euro. The current exchange rate is 1:1. The forex trader invests a total of 1,000 euros through his broker. This is exactly where the leverage mechanism comes in. Suppose the leverage is 1:10. Then the trader actively moves 10,000 euros in the financial markets. This is made possible by the broker, who acts as an intermediary. The market develops as expected by the trader. He closes his position, ie sells the dollar, at the rate of 1 euro for 0.9 dollar. The trader would now receive EUR 1,111.11 for his $1,000 he actually held, resulting in a profit of EUR 111.11. However, the trader actively moves 10,000 euros in the financial markets. This results in a gain of 1,111.11 euros, ten times the gain that would have been possible without leverage.
The most important currencies at a glance
The currencies of large economic areas or important financial centers are most often traded on international markets. Combinations of these are also called “majors”. The most traded currencies in FOREX trading (FX trading / currency trading) are:
- American dollar
- Pound sterling
- japanese yen
- Swiss franc
Conclusion: Forex trading is trading in foreign currencies (FOREX)
Foreign exchange is a combination of different currencies. These currency pairs can be traded daily on the stock exchange. However, foreign currencies are not physically acquired. Currency trading (FOREX trading) is done almost entirely through financial derivatives. If you want to trade forex, all you need is a common deposit with a broker. Professionals can also conduct FOREX trades through specialized FOREX brokers who specialize in these types of trades.