How Does Forex Trading Work?

Investing in forex trading is one of the popular ways of investing your money. Learning how to invest in forex trading is crucial to earn maximum profit. As with everything else you need to know how this works so that you get the best outcome of it. Nowadays, with all the help available online, it has become easy to learn trading. Before we get into how the forex trading works, let us first discuss what forex is. 

What is Forex?

Forex is also known as foreign exchange, currency trading or FX. Forex is the conversion of one currency into another. Forex is a global financial market where all the world’s currencies trade. The forex market is the largest market in the world where average daily trading volume exceeds $5 trillion. Now that we know what is forex? Let us understand what forex trading is.

What is Forex Trading? 

Forex trading is a network of sellers and buyers who exchange currency between each other at an agreed price. It is a platform through which companies, central banks or individuals convert one currency into another. If you have ever travelled overseas it is likely that you have made a forex transaction. For example you take a trip to France then you will have to convert your dollars into euros. When you do this you are trading money means you are exchanging one currency with another currency. The forex exchange rate between the two currencies determines how many euros you get for your dollars. The exchange rate depends on supply and demand and it fluctuates continuously. 

A lot of forex trading is done for the practical purposes. However a majority of foreign exchange is made with an aim to earn profit. The amount of currency converted everyday can increase the rate of that particular currency. 

How Does the Currency Market Work?

Forex trading takes place between two parties directly in an OTC (over-the-counter) market. The forex market is run by a global network of banks. These banks are spread across four major forex trading centers in different time zones i.e New York, London, Tokyo and Sydney. Because there is no central location where you can trade forex 24/7. 

Forex markets are of three different types.

  • Future Forex Market

In this type, a contract is agreed where transactions involve future delivery and future payment at an agreed exchange rate that is also called the future rate. These agreements are standardized. The terms and conditions in the contract are non-negotiable. These markets are popular among those traders who make large currency transactions are interested in a steady return from their investment. 

  • Spot Forex Market

In foreign markets, these are the quickest transactions involving currency. It is the physical exchange of a currency pair at the current exchange rate that is also called the spot rate. Spot market accounts for one third of all currency exchange. The trades in this market usually take place within two days of the agreement. It leaves the trader open to volatility and the exchange price can go upwards or downwards between the time period of trade and agreement. 

  • Forward Forex Market 

This market is quite identical to the future forex market. In this type, a contract is agreed to sell or buy a specific amount of currency at a set price to be settled at a fixed date in future. But there is a difference which separates it from the future forex market. Unlike future forex market in forward forex market the terms of agreement are negotiable between the two parties.  It allows for flexibility. The terms of agreement can be tailored to the needs of the participating parties. 

Ways of doing Forex Trading as an Individual Trader

Forex trading can be done in a number of different ways. All of the ways work in the same way which is the simultaneous purchase and sale of currency. But what type of way you want to choose for the forex trading is the next question. 

Most of the time forex trading takes place between major financial institutions and banks. They purchase and sell huge amounts of currency on a daily basis. Though you can not make a million or billion dollar trade as an individual trader. However there are two main ways to get yourself into forex trading as an individual trader i.e trading through a broker or Forex CFDs.

  • Forex Trading Through a Broker

Forex brokers are the firms that provide you with a platform which gives you access to make transactions. A forex broker makes it possible for you (as a trader) to open a trade by buying a currency pair and close the trade by selling that same pair. 

While making forex trading through a broker you do not take the ownership of the currencies on your own. You only speculate the price movements of the currency pair. When you trade via a broker you will not have access to other markets. 

  • Forex CFD

Forex CFD is a contract that makes you agree upon to exchange the difference in price of a currency pair from when you open your position to when you close your position. If you open a long position and the price increases at the time when you close then you will make a profit. But if the price drops during that position then you will have to face the loss.