What is Forex Trading and How Does It Work?

Forex is a term that became popular over the past decade to bring more people to the trading circle. Foreign exchange can be defined as a network that consists of buyers and sellers, who indulge in the trade of currencies. An agreed price is paid to the seller for the currency that the buyer purchases. Individuals and organizations convert their currencies through this medium. Even the ones who travel abroad and convert their currency for the local currency is inadvertently involved in a forex trade. These transactions are activities done for practical purposes, whereas several other exchanges are a means of making a profit. Better profits can be brought about by the volatility of the forex market. It could also be a risk if the user doesn’t handle his/her finances properly. Let us have a closer look at the working of the foreign exchange.

Working of the Foreign Exchange Markets

The over-the-counter approach of the forex market makes it a unique form of trade. Unlike in commodities or shares, the trade is done directly between two parties and not through an exchange. The global market of forex functions all through the year by favoring all the time zones. Forex market is of three types:

Spot Forex Market

In the spot forex market, the exact point where the trade is settled witnesses the physical exchange of a currency pair within a short time.

Forward Forex Market

In this type, a set amount of currency is exchanged at a specified price within the predetermined expiration date. All of these are to be conducted just as how the stipulations have been mentioned in the contract.

Future Forex Market

Within a set date in the future, the buyer and the seller must trade the currency for the set amount of money. It is similar to forwards in its fundamental concept but is legally binding, unlike forwards.

Forex Pairs

 Foreign exchange is done using two different currencies where the buyer and seller are based. Currency pairs are, therefore, used in the process of exchanging money. The first currency listed in a forex pair is called the base currency, and the currency that takes the second spot is known as the quote currency. The price of these pairs is defined by the amount of money in quote currency required to buy one unit of the base currency. A three-letter code is used to list each currency in a pair, and of these three letters, the first two stands for the region where it valid, and the last letter stands for the currency.

GBP/USD is one such pair that is considered to have great value, offsetting each other’s price over time. The pair’s price will increase when the value of pound rises above the dollar because a single will then be worth more dollars than earlier. It is always the base currency that determines the price of the pair, meaning if the value of GBP falls significantly against the dollar, the price of the pair also drops. The four types of currency pairs are major pairs, minor pairs, regional pairs, and exotics.