What is Forex?

If you have reached this page, it means that you are intrigued to know how this market works which is extremely popular. Here you will find the concepts you need to understand better. What is forex ?.

What is Forex or Forex Market?

FOREX are the initials of the Foreing Exchange, it is also known as the Forex market because they are buying and selling currencies from around the world. Forex is the largest financial asset market worldwide: The daily trading volume amounts to more than 5 billion dollars. This volume is greater than the sum of all stock exchanges.

The foreign exchange market, however, is not just a market for financial speculation, it has ancient origins and arises due to the commercial needs of exchanging one currency for another, to carry out transactions. The negotiations, nowadays, take place in the so-called interbank market which operates 24 hours a day, 5 days a week. The foreign exchange market operates thanks to a global interbank network, distributed in four main financial centers that cover all global time zones (London, New York, Sydney and Tokyo).

What is Forex trading?

Currency trading is nothing more than buying / selling currencies. Like us, central banks, corporations, investors and ordinary traders negotiate in the foreign exchange market to meet various needs, including international trade, tourism, investment, market stabilization or simply to deal with to generate profits through the difference between the purchase price and the sale price.

 

 

 

What is a Forex broker?

Brokers are no more than intermediaries that provide operators with the opportunity to access the interbank market 24 hours a day to conduct transactions in the currency market.

AvaTrade is one of the leading brokers in the world, duly regulated by 6 global supervisory bodies. Avatrade’s perspective is user-oriented, providing personalized services based on the individual objectives and needs of each client, whether they are novice traders or experienced traders.

Types of Forex Contracts

Contracts are tools used to buy or sell a currency. In forex there are different types of contracts, then we present 3 types of contracts

  • Spot Contracts
    Forex spot contracts are contracts in which the parties agree to buy and sell a currency at the current market price. This contract is executed «spot», that is, immediate form.
  • Forward contracts
    Forward contracts, also known as Forward contracts, are currency purchase and sale contracts that stipulate a specific price in which one currency must be exchanged for another in the future. This type of contract is commonly used in commercial strategies to establish an order at a specific price that is not currently available.
  • Futures contracts
    Forex futures contracts are contracts in which currency trading is agreed at a specific price on a specific date. The substantial difference between forward contracts and futures contracts is that futures contracts are binding on the parties, who must comply with the exchange contract on the due date.

 

 

 

 

 

What are currency pairs?

Transactions in the forex market always involve the contextual sale of one currency and the purchase of another. That is why we are talking about «currency pairs». For example, the Eurodollar is known as EUR / USD. The currency on the left is known as the main currency or base currency, while the currency on the right is the secondary currency. In our case, the euro (EUR) is bought or sold by obtaining a certain amount of secondary currency in exchange, depending on the applicable exchange rate.

 

 

In the market we see the quotes expressed with two reference prices, eg. EUR / USD 1.1534 / 1.1536. The price on the left is known as the «bid» price or money price and is the price at which an operator is willing to buy a currency pair. Conversely, the price on the right is called the «ask» price, that is, the price at which an operator is willing to sell a currency pair. The differential between the bid price and the ask price is commonly known as the spread term in English. This is the cost of the commercial operation. In our example, this differential is 0.0002. For convenience this differential is indicated as 2 pips (What is pip?).

Prices in the currency market are usually negotiated in the fourth or fifth decimal place, since a variation of a few pips can generate considerable variations in the case of large trading volumes.

Classification of currency pairs

As we have seen, currencies are traded in pairs. Although virtually any world currency can be exchanged for another, there are some currencies that attract a greater volume of trade, mostly based on the importance of the reference economy and the global trade performed. Currencies are commonly classified in Major Currency Pairs, Minor Currency Pairs and Exotic Currency Pairs:

 

  • Senior currency pairs
    In this group are the most traded currencies and represent more than 80% of the total trade that takes place in the currency market. The high availability and liquidity of these currencies ensure that trading conditions are particularly advantageous, with relatively low differentials compared to other less commercialized pairs. 

    Peer Abbreviation FX Description

  • EUR / USD Euro – United States Dollar (euro dollar)
  • GBP / USD British Pound – US Dollar
  • USD / JPY US Dollar – Japanese Yen
  • USD / CHF US Dollar – Swiss Franc
  • USD / CAD United States Dollar – Canadian Dollar
  • AUD / USD Australian Dollar – American Dollar (aussie)
  • NZD / USD New Zealand Dollar – American Dollar (kiwi) 

    Minor currency pairs

These are less liquid currency pairs than the larger pairs and, sometimes, they are also known as currency crosses or simply crosses. These are pairs in which the US dollar is not present, but include the major world currencies, such as the euro, the pound sterling or the Japanese yen. Among the most common minor pairs are EUR / CHF, EUR / NZD, GBP / AUD, GBP / AUD, GBP / JPY, CAD / JPY, etc.

 

Exotic currency pairs

The so-called «exotic» currency pairs are those that affect the currency of an emerging market. These currencies have a low liquidity and a very low trading volume, compared to other pairs. Among the most popular exotic pairs are USD / TRY, USD / MXN and USD / ZAR.

 

 

 

 

Factors that influence the trend of exchange rates in the foreign exchange market

Macroeconomic factors

For example, the political instability of a country, wars, large operations of central banks, multinational corporations, etc.

Microeconomic factors

Inflation
Financial speculation
Offer / Demand

Economic Events

To assess and try to predict the performance of currency markets, AvaTrade’s economic calendar and the analysis provided in the SharpTrader training portal can help.

 

Why operate Forex?

Traders operate in the currency market mainly for two reasons: buying and selling currencies to operate in the goods and services sector or financial speculation.

Sale and purchase of goods and services abroad.

In a global economy, companies that operate abroad and buyers that want to buy outside of their reference market must convert their currency to conclude an international commercial operation. For this reason, forex is of fundamental importance for companies and individuals that operate on an international scale.
This is the most common way of trading. Every time a person or a company needs to buy something in a foreign currency, it is necessary to carry out a forex operation. Therefore, forex is of fundamental importance for international trade. Trade in the foreign exchange market is done continuously, day and night, but currency trading motivated by the sale of goods and services constitutes a relatively small part of total transactions.

Speculation

Most of the transactions that take place in the currency markets are intended to generate profits. Investors who speculate in this field are not interested in owning a foreign currency in order to use it, but intend to take advantage of market fluctuations exclusively by taking advantage of the difference between the purchase price and the sale price (or vice versa).

Many operators tend to operate with a short-term time horizon, sometimes with different transactions open and closed on the same trading day. This category of trader is called day trader. The simplicity with which it is possible to trade in the currency market makes currencies an extremely liquid asset and this is the basis of a comparatively higher volatility compared to that of other markets that enjoy a smaller volume of trade.

 

How to open a position in Forex?

Opening a position on the MetaTrader 4 trading platform is really simple.

1. Open an AvaTrade account
2. Download MetaTrader 4 and install or access MetaTrader Web Trader directly from your web browser.
3. In this demo we will use the MetaTrader website.

 

 

4. At this point we will enter the main MetaTrader screen. On the left, we find the main currency pairs exchanged in AvaTrade and, on the right, the graph with the trend of the selected pair, in our case the popular EUR/USD.

 

5. By default, traders see the platform in English. If we want to change to the Spanish version, we click on View> Languages> Spanish and confirm the selection by pressing «Restart».

 

6. To open a position, simply double click on the pair in which you want to trade on the left.

Afterwards, a window is displayed, called «Order», which indicates the desired symbol (EURUSD), the volume of the desired lots (1 lot = 100,000), the stop loss value and the profit taking that we want to establish (optional but suggested) and a red button «Sell by market» to sell, or blue «Buy by market» to buy.

Forex Glossary

Appreciation: A currency is said to be «appreciated» when its value increases as a function of market demand.

Arbitrage (Arbitrage): Operation consisting in buying or selling a security by immediately doing the inverse operation in another market, in order to benefit from the existing exchange difference between two places.

Around: Colloquial term used by operators to indicate when the term / discount premium is close to parity. For example, «two-two around» would be understood as 2 pips of difference between the current purchase and sale price of the market.

Ask Rate: The price at which an instrument is offered for sale (as well as the difference between the purchase and sale prices)

Asset Allocation: Investment practice that consists of the distribution of assets in different markets, to obtain diversification for the purposes of risk management and / or obtain the expected return based on the objectives of the investor.

Back Office: The departments and processes related to the settlement of financial operations.

Balance of Trade (Balance of Trade) – Value of a country’s exports minus the value of its imports.

Base Currency: In general terms, the currency in which the investor or issuer keeps his account book. In the Forex market, the US dollar is usually considered the «base» currency for the quotes; that is, the quotes are expressed as a unit of $ 1 USD for the other currency quoted in the pair. The main exceptions to this rule are the British pound sterling, the euro and the Australian dollar.

Bear Market (Bear market): A market characterized by low prices.

Bid / Ask Spread (Difference between purchase and sale price): Difference between purchase and sale prices; the most used way to measure the liquidity of the market.

Big Figure: Expression used by the stock broker (dealer or trader) that refers to the first digits of the exchange rate. These digits do not change frequently in the normal fluctuations of the market and, therefore, are eliminated from the agents’ quotes, especially during periods of high activity in the market. For example, the USD / Y exchange rate could be 107.30 / 107.35, but agents will not mention the first three digits, that is, they will say «30/35».

Book (Book): In a field of professional sales, the book summarizes the total positions of an operator or money table.

Broker (Broker): A person or company that acts as an intermediary between buyers and sellers and receives a fee or commission for the transaction. On the other hand, a «dealer» or «trader» (agent, trader) commits his capital and takes a position, hoping to obtain a difference (gain) by closing the position in a subsequent transaction with another party.

Bretton Woods Agreement of 1944 (Bretton Woods Agreement of 1944): Agreement that established fixed exchange rates for major currencies, stipulated the intervention of the central bank in the currency markets, and set the price of gold at US $ 35 per ounce. This agreement was in effect until 1971, when President Nixon left it without effect and established a floating exchange rate for the main currencies.

Bull Market (Bull Market): A market characterized by high prices.

Bundesbank: Central Bank of Germany.

Cable (Cable): Colloquial term used by the operators to refer to the exchange rate of the pound sterling and the dollar. It is so called because the exchange rate was originally transmitted by transatlantic cable from the middle of the 19th century.

Candlestick Chart (Chart of candles): Graph that indicates the range of operation of the day like the prices of opening and closing. If the opening price is higher than the closing price, the rectangle between the purchase and closing price appears shaded. If the closing price is higher than the opening price, that area does not appear shaded.

Central Bank (Central Bank): A governmental or quasi-governmental institution that manages the monetary policy of a country. For example, the central bank of the United States is the Federal Reserve and the German central bank is the Bundesbank.

Chartist: Person who studies the tables and graphs of historical data to discover trends and anticipate changes in trends. He is also known as a Technical Trader.

Clearing (Clearing): The process of liquidating an operation.

Contagion (Contagion) – The tendency of an economic crisis to spread from one market to another. In 1997, Indonesia’s political instability generated great volatility in its currency, the rupee. Then, the contagion affected other currencies of emerging Asian countries, and then came to Latin America, and is now known as «The Asian Contagion.»