The foreign exchange market, or forex is a decentralized marketplace where currencies are traded. This is done electronically over-the-counter (OTC), which means that all transactions take place via computer networks between traders all over the world, as opposed to one centralized exchange.
Just like any other market, forex functions at the expense of supply and demand. For example, if European citizens in possession of Euros wish to acquire the US Dollar, they will create a demand for it and exchange their Euros into Dollars. As a result, the US Dollar will rise in value and consequently the Euro will fall. Other contributing factors to the FX market movements include broad macroeconomic events such as a new presidential election or country specific factors such as inflation and unemployment, just to name a few. In order to stay on top of these influential factors, traders can make use of an economic calendar and of course staying up to date with current affairs that may have the potential to move the market.
How does it work?
To put it simply, if you think a currency is going to shoot up in value, you buy the currency. This is known as going long. If you feel the currency is going to drop, you sell that currency. This is known as going short. Within the foreign exchange market there are two types of traders, hedgers and speculators. Hedgers are constantly attempting to dodge extreme movements in the exchange rate. While speculators are drawn to risk and are always looking to take advantage of any volatility in exchange rates.
Why Trade Forex?
As the most traded market in the world, Forex has many advantages over other markets. These are:
- Low Transaction Costs
The cost of a transaction is typically accounted for in the form of a spread, which is where Forex brokers generally make their money. A spread represents the difference between the bid and the ask price and is measured in pips.
- High Liquidity
Liquidity represents how quickly an asset can be converted into cash. High liquidity in the world of Forex means that substantial amounts of cash can be moved in and out of currencies with generally small spreads. With an average daily turnover of $5.1 trillion, it’s safe to say that the foreign exchange market is the most liquid financial market in the world.
- Substantial Leverage
Trading Forex allows you to take a position in the market you would not have otherwise been able to take due to the degree of leverage available. However, as much as leverage may increase your winnings it may also backfire and increase your losses. Thus, it is essential to understand the risks of trading on margin.
You can practice trading on margin through a free CedarFX demo account, which gives you access to up to 1:500 leverage on all FX pairs.
- 24-Hour Availability
One major draw of the Forex market is that the currency markets are open 24 hours a day, five days a week. With currencies traded across almost every time zone, it’s safe to say that the forex market can be extremely active any time of the day with constant price fluctuations.
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