On the global financial markets, foreign exchange (foreign exchange) plays an important role. The foreign exchange market is the world’s largest financial market, with a daily turnover of $5 trillion (!). But, first and foremost, what is foreign exchange? Foreign exchange, in general, refers to the exchange of one currency for another. For example, if investors want to buy US government bonds, they must first convert their euros into US dollars. However, foreign exchange can be traded as well. The following guide serves as an introduction to the subject and explains key foreign exchange trading mechanisms.
What is the definition of foreign exchange?
Foreign exchange is nothing more than a collection of claims on other countries’ currencies. Deposits, checks, bonds, and foreign currency exchanges are examples of these. The term is commonly used as a synonym for “currencies,” as stated in the introduction to this guide. In a strict sense, this is incorrect. The denominations of foreign banknotes are the same as the denominations of domestic banknotes.
Forex, on the other hand, is a currency pair. The value of two currencies is always exchanged. For example, investors can only purchase the US dollar if they simultaneously sell the euro or another currency. The exchange rate, also known as the foreign exchange rate, is the rate at which two currencies are exchanged. After the decimal point, quotations are made up to the fourth digit.
The exchange rate is typically expressed as a price quotation. This means that the number of units of foreign currency that must be paid for one unit of local currency is specified.
For example, if the euro to US dollar exchange rate is 1.3, then 1.3 US dollars must be paid per euro. If you want to exchange euros for US dollars, however, you will get exactly 1.3 US dollars for each euro.
The most important currencies at a glance
On the international markets, the currencies of large economic areas or important financial centers are traded the most. “Major” is a term that refers to a combination of these. The following are the most commonly traded currencies in FOREX trading (FX trading / foreign exchange trading):
- U.S. dollar
- British pound
- Swiss franc
- Japanese yen
What is FOREX (foreign exchange) trading?
Foreign exchange trading is accessible to even small investors. The physical acquisition of a foreign currency, on the other hand, is extremely rare. Rather, the right to a specific currency is purchased in forex trading, but the currencies do not physically change hands. Forex trading is done through the use of financial derivatives. Here, options are used in particular. Simply put, the value of these financial derivative instruments moves in lockstep with the value of the underlying currency pair. The financial products merely facilitate foreign exchange trading by removing the need for physical currency transfers. Many of these financial derivatives come with what’s known as leverage. This enables traders to move more money on the financial markets than they would normally use. This is done in part through regular online brokers, but FOREX brokers who specialize in Forex trading australia are also available.
This may appear perplexing at first, but forex trading is easily explained using a simple example:
The dollar is expected to appreciate against the euro, according to a forex trader. At the moment, the exchange rate is 1:1. Through his broker, the currency trader invests a total of 1,000 euros. This is where the lever mechanism enters the picture. Assume the leverage is one-to-ten. The trader then engages in active trading on the financial markets, moving 10,000 euros. The forex online broker, who acts as a sort of middleman, makes this possible. The market moves in the direction predicted by the trader. He sells the dollar at a rate of 1 euro for 0.9 dollars to close his position. The trader would now receive EUR 1,111.11 for the $1,000 he was actually holding, making a profit of EUR 111.11. The trader, on the other hand, has made 10,000 euros in the financial markets. This yields a profit of 1,111.11 euros, which is ten times the profit possible without leverage.
Conclusion: Forex trading is trading in foreign currencies (FOREX)
The term “foreign exchange” refers to the mixing of different currencies. On the exchange, these currency pairs can be traded on a daily basis. Foreign currencies, on the other hand, are not actively acquired. Financial derivatives are used almost entirely in foreign exchange trading (FOREX trading). To trade foreign exchange, all you need is a standard deposit with a broker. Professionals can also engage in FOREX trading through specialized FOREX brokers who specialize in such transactions.