What is Forex?
The foreign
exchange market, also known as Forex, FX, or the currency
market, is a global, decentralized, over-the-counter (OTC) marketplace
where currencies are traded. This market determines the exchange rates for
all currencies worldwide. In terms of trading volume, it is the largest
financial market in the world, far exceeding the credit market.
In Forex
trading, profits are made by speculating on whether the value of one
currency will rise or fall compared to another, such as EUR/USD. The
foreign exchange market plays a crucial role in international trade and
investment by enabling currency conversion. For example, it allows a
business in the United States to import goods from European Union countries and
pay in Euros, even though its revenue is earned in US dollars.
Additionally,
the Forex market supports direct currency speculation, valuation of
currency strength, and carry trade strategies, which are based on
the interest rate differences between two currencies.
The
foreign exchange market is unique due to the following features:
- Extremely high trading volume, making it the largest
asset class in the world and resulting in high liquidity;
- Global presence, with trading activity
spread across different countries and time zones;
- Continuous trading hours, operating 24 hours a
day on weekdays, from 22:00 UTC on Sunday (Sydney) to 22:00
UTC on Friday (New York);
- Multiple influencing factors that impact currency
exchange rates;
- Relatively low profit
margins
compared to other fixed-income markets; and
- Use of leverage, which can increase both
potential profits and losses relative to the size of the trading account.
What Are Currency Pairs?
A currency
pair represents the relative value
of one currency compared to another in the foreign exchange market.
The currency used as the reference is known as the counter currency, quote
currency, or simply the currency,
while the currency being valued is called the base currency or transaction
currency.
Currency pairs are classified into three main categories:
1. Major Currency Pairs
The most frequently traded currency pairs worldwide
are known as Major pairs. They
make up around 85% of total trading volume
in the Forex market, which results in high liquidity.
Examples:
· EUR/USD
· GBP/USD
· USD/JPY
· USD/CHF
Characteristics:
✔
High liquidity
✔
Low spreads
✔
Suitable for beginners
2. Minor Currency Pairs
Minor currency
pairs are traded less frequently than major pairs and do not include the US Dollar.
Examples:
· EUR/GBP
· EUR/JPY
· GBP/JPY
Characteristics:
✔
Moderate liquidity
✔
No USD involvement
3. Exotic Currency Pairs
In addition to
major and minor pairs, there are exotic
currency pairs. These pairs combine a major currency (such as USD, EUR, GBP, or JPY) with a thinly traded currency that has low trading volume in the Forex market.
Examples:
· USD/INR
· USD/SGD
· EUR/TRY
Characteristics:
- Higher spreads
- Greater risk
Key Forex Terminology – Detailed
Explanation
1. Pips and Points
A pip (percentage in point) is the standard unit used to measure price movement
in a currency pair.
· For most pairs, 1 pip = 0.0001
Example: If
EUR/USD moves from 1.1000 to 1.1005,
it has moved 5 pips
A point is sometimes used to describe smaller price movements or fractional
pips, depending on the broker.
2. Bid and Ask Price
· Bid price:
The price at which the broker is willing to buy a currency pair from you
· Ask price:
The price at which the broker is willing to sell a currency pair to you
Traders buy at the ask price
and sell at the bid price.
3. Spread
The spread is the difference between the bid and ask prices.
It represents the broker’s cost or profit
for executing a trade.
Example:
· Bid: 1.1000
· Ask: 1.1002
· Spread: 2 pips
Lower spreads
are generally better for traders.
4. Leverage
Leverage allows traders to control a larger trading position with a smaller amount of money.
Example:
· Leverage 1:100
· With ₹1,000, you
can control a position worth ₹100,000
While leverage
can increase profits, it can
also increase losses, making
risk management essential.
5. Margin
Margin
is the amount of money required in your
trading account to open and maintain a leveraged trade.
It is not a fee, but a portion of your funds
that is set aside by the broker as security.
Example:
· Margin
requirement: 1%
· Trade size:
₹100,000
· Required margin:
₹1,000
6. Orders
An order is an instruction given to a broker
to open or close a trade under specific
conditions.
Common types of
orders include:
· Market Order: Executes immediately at the current price
· Limit Order: Executes at a specified better price
· Stop-Loss Order: Limits potential loss
· Take-Profit Order: Locks in profits at a target price
Forex Market Sessions
The forex market functions 24 hours a day because it operates across
multiple global time zones. When trading ends in one major market, another
market begins, allowing currency trading to continue round the clock, five days a week.
Forex trading
takes place in an Over-the-Counter (OTC)
system, where transactions are carried out electronically through a worldwide
network of banks and trading platforms, rather than through a single physical
or centralized exchange with fixed operating hours. This structure enables
traders to participate in the market at nearly any time during the day.
|
Major market |
Forex market timing (in UTC) |
|
Sydney |
9:00 PM to 6:00 PM UTC |
|
Tokyo |
11:00 PM to 6:00 AM UTC |
|
London |
7:00 AM to 4:00 PM UTC |
|
New York |
12:00 PM to 9:00 PM UTC |