What is the currency exchange market, and how does it work?

Created in 1971, Forex is a decentralized international market where all world currencies are traded. It is an over the counter place open 24 hours a day from Sunday evening to Friday evening. More than 5 trillion dollars are traded there every day.

On Forex, trading is carried out through computer networks linking traders (also called currency traders) via electronic platforms.

Choosing the right platform or a broker for your trades is crucial for your success on the market. It’s always recommended to read reviews such as Lexatrade review and see what those platforms have to offer in terms of trading conditions.

The exchange rate between currencies (equilibrium price) is sensitive to several factors: all economic events (change in interest rates, inflation, growth rate, etc.) as well as political events, market sentiment, natural disasters, etc.

 The value of a currency is always denominated against another currency. Thus, we will say that one euro is worth 1.18 dollars. Some of the most traded currencies in Forex include the dollar, euro, British pound and Japanese yen, all of which are considered reserve currencies by central banks (which store them).

How Forex Works

Several players are found on the foreign exchange market: central banks, commercial banks (and financial institutions), companies, hedge funds and, at the margin, certain individual investors who play one currency against the other through derivative products such as CFDs etc.

All these players can trade currency pairs with guaranteed liquidity. Each pair, for example, the EUR/USD, is made up of a reference currency (for example, the euro) and a counter currency (for example, the dollar). It is the evaluation of the reference currency with regard to its counterpart that provides the quotation.

The dollar remains the benchmark safe-haven currency. It is the first currency used and traded globally: 85% of Forex transactions involve US dollars.

Each time a currency is sold, its relative value compared to other currencies decreases since the supply is greater than the demand. The downward movements can be spectacular. Thus, during the standoff between Washington and Ankara (summer 2018), the Turkish lira recorded a drop of 19% against the dollar over one day.

In Forex, most currencies are quoted with the unit of the 4th decimal place. The fourth digit after the comma is called “pip”. It defines the change in value between 2 currencies. The smallest movement is therefore equivalent to 0.0001 (4th digit after the decimal point). If the EUR/GBP pair moves from 0.8978 to 0.8979, the pair is said to have risen by one “pip”.

The exception to this system concerns pairs involving the Japanese yen. In this case, a pip corresponds to the movement of the second decimal place after the comma.

Forex profits are generated by the appreciation or depreciation of one currency against another. For example, if you buy dollars with euros, you will have to wait for the value of the single currency to increase against the greenback before reselling it, generating an exchange gain.

Currency traders, specialized brokers who intervene on the foreign exchange market on behalf of investors, are remunerated on the difference (spread) between the buying and selling prices that they negotiate for each investor (for example, a bank and a business). The prices being volatile, the promises of daily gains are considerable.

 

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