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What is Forex? | Rakuten Securities HK

What is forex trading? It refers to the trading in the foreign exchange market. Forex traders tend to purchase currencies that are undervalued and sell currencies that are overvalued so as to earn capital gain.

Basic concept of what is Forex

Short for Foreign Exchange, Forex is a decentralized market where anyone can speculate currencies around the world. It is known to be the most liquid market in the world with a daily trading volume that goes over $5 trillion. Different economies deal in different currencies.

When you travel to another country, you are required to use the currency prevalent in that country. So if you have travelled abroad, you have most likely dealt in foreign exchange already. This exchange of one currency into another can lead to considerable profits and losses when done on a large scale. This is why it has become popular for speculation and has evolved as a market of its own. So to answer the question, “What is forex?” it is the speculation of currencies.

Pairing currencies

Every time you want to make a trade-in forex, you will require to pair one currency with another. Online trading platforms provide the currency pairs in which you can trade. Trading in forex requires you to bet one currency against the other by speculating if a currency would rise or drop in value against the other. For example, if you bet the Chinese yuan against the US dollar, keeping in mind that the Chinese yuan would drop in value, then you can open a sell position for the Chinese yuan against the US dollar. If the Chinese currency, however, starts to rise in value, then you will start losing so you would want to get out of the trade.

The most popular currency pair in the world is the Euro and the US dollar. If you trade in EUR/USD, then the first currency which is Euro is the base and you will see the value of that currency as compared to the second one. In a EUR/UD pair, you will see how much a Euro is worth in US dollars. There are two values mentioned for every pair. One is the buy and the other is the sell value.

What is Forex used for organization?

Organizations use Forex to hedge funds

Companies who usually operate in multiple international markets trade in Forex to hedge funds and reduce losses caused by the change in currency value in the markets that they deal in. If a certain currency goes stronger or reduces in value, it can greatly affect the profits of a company which operates out of that country or plan to sell products in that market. For example, a product is manufactured in the US market for $100 and will be sold in the European market for 120 euro at a time when the US dollar and Euro are in parity meaning it costs $1 to buy 1 euro. The total profit will be $20.

But the US dollar gets stronger and by the time the product is actually sold in the European market, it costs $0.90 to buy 1 euro. This means that the overall profits earned from the sale of the product will reduce as a result of the dollar getting stronger. Even though the product will still be sold at 120 euro, the profits will reduce since the value of the product in dollars will be $108. The profit, as a result, is of $8 only.

If the company traded in the currency pair when it was in parity, then it could profit from buying the US dollars and these profits can hedge the losses incurred from the sale of the products in the European market.

What is Forex used for banking?

Banking institutions

Banks trade in forex on behalf of their clients and also use forex for speculation through their trading desks.

What is Forex used for investment managers?

Investment managers

Just like organizations operating in international markets, investment managers also trade in forex to hedge funds.

What is Forex used for individual investors?

Individual investors

Even though individual investors are still relatively low, more traders are beginning to speculate in forex for profits.


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What Is Forex

Forex / FX is a commonly used abbreviation for “foreign exchange”. It typically describes trading in the foreign exchange market, especially by investors and speculators. “Buy Low and Sell High” means a forex trader purchases currencies that are undervalued and sells currencies that are overvalued; just as stock trader purchases stock that is undervalued and sells stock that is overvalued.

 

This is similar to stock trading. Stock traders buy a stock if they its price will rise, and vice versa. Forex traders employ this same pattern- to buy a currency pair if its exchange rate will rise and to sell a currency pair if its exchange rate will fall.

 

 

Example
Imagine a situation where the U.S. dollar is expected to weaken in value relative to the euro. A forex trader in this situation will sell dollars and buy euros. If the euro strengthens, the purchasing power to buy dollars has now increased. The trader can now buy back more dollars than they had to begin with, making a profit.

 

Exchange Rate

Exchange rate is the relative value of different currencies which are determined by a decentralized foreign exchange marketplace. Unlike other markets, there is no centralized depository or exchange where transactions are conducted. Instead, these transactions are conducted by several market participants in several locations. It is rare that any two currencies will be identical to one another in value, and it’s also rare that any two currencies will maintain the same relative value for more than a short period of time. In forex, the exchange rate between two currencies constantly changes.

 

 

Example
In November 2015, one euro was worth about $1.05. By April 2016, one euro was worth about $1.16. The euro increa-sed in value by about 10.5% relative to the U.S. dollar during this time.

 

EUR/USD Exchange Rate

 

A currency’s value fluctuates as its supply and demand fluctuates.

  • An increase in supply or a decrease in demand for a currency can cause the value of that currency to fall.
  • A decrease in the supply or an increase in demand for a currency can cause the value of that currency to rise.

A big benefit to forex trading is that you can buy or sell any currency pair, at any time subject to available liquidity. So if you think the Eurozone is going to break apart, you can sell the euro and buy the dollar (sell EUR/USD). If you think the price of gold is going to go up, based on historical correlation patterns you can buy the Australian dollar and sell the U.S. dollar (buy AUD/USD).

 

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