If you are travelling to a foreign land, apart from getting your passport and visa ready, what is the first thing that you have to do? You visit the bank and apply for an international travelling card or a forex card. Say, you are travelling from the US to Great Britain; you need to preload this card with USD and only then will you be able to pull out pounds while in London. So, you basically went for currency exchange as every currency come with different valuations. In a similar fashion, this is how forex trading works.
The foreign exchange market is a global currency exchange market that trades with currency. Every currency comes with different valuations against a set standard and the difference in currency valuations can be used to make a profit. Not only for trading, but currency conversion is also necessary if you decide to purchase any foreign commodity, and the conversion rate will determine the ultimate cost incurred. Read on to find out more about forex trading and how it works.
How forex trading works
Say, you have put in $10,000 into your forex card. Your bank will tell you that the conversion rate is 1.30 and puts in 7,702.68 British Pounds (GBP) into your account. In simple words, you paid USD 1.3 to buy 1 GBP. In the forex market, currency is sold and bought same as a commodity.
Now, this conversion rate or market quote of USD to GBP is not stagnant and fluctuates over time. Forex market is known as the most liquid financial market in the world, and the quote may vary within a span of minutes. A country’s economy, its international relations, internal political scenario and various other factors determine its currency valuation.
Had the rate been 1.1, you would have received more GBP with $10,000. If the rate was 1.5, the amount of GBP would have been less. Similarly, this market allows you to sell GBP and get back your USDs. So, if you had bought GBPs at exchange rate 1.3 and sold them at 1.5, you would receive more USDs than you had initially paid, thereby making a profit. This is a simple way to answer your query, “What is forex trading and how it works.”
Forex Trading – types
It just does not involve currency exchange. Trading is mainly carried out by individuals or corporations, and they mainly have the option to do it in the following three ways:
Spot market – this is where the currency is bought or sold based on the current market quote. With the advent of electronic trading, this form has seen a surge and is the most popular form now.
Forwards market – contracts are bought and sold between two parties and is based on a certain agreement.
Futures market – here, future contracts are exchanged based on a specific size and future time of settlement.
A thorough understanding of the above three forms is necessary to grasp the concept of “forex trading how it works.” Though, individuals and newbies prefer spot market over the other two, understanding all keeps avenues open for profitable trading.
If you are thinking of investing in this market, remember that this is a $5.3 trillion daily transaction market and investing just by understanding how forex trading works is not wise. It requires a host of pre-requisites and research before you can actually go on to make a profit.
The content of this article reflects the author’s opinion and does not necessarily reflect the official position of LiteForex. The material published on this page is provided for informational purposes only and should not be considered as the provision of investment advice for the purposes of Directive 2004/39/EC.