FOREX MARKET

FOREX-MEANING:

Forex stands for foreign exchange which is the place where currencies are traded. The foreign

exchange or forex market is a global marketplace for exchanging national currency.

FOREX-DEFINITION:

Foreign exchange helps to convert the currency of one country into another as different

countries have different currencies. A foreign exchange rate is defined as the price of the

domestic currency with respect to another country.

HISTORY OF FOREX:

The forex history can be dated back to 6000BC.it was first introduced by the

Mesopotamian tribe. The exchange first was in the form of a barter system where goods were

exchanged for goods, then salt and spices were used as a medium of exchange. The gold standard

system was in existence and finally, a free-floating system was attained where the exchange rate

was not backed by any government regulation but was determined by the forces of demand and

supply.
FUNCTIONS OF FOREX:

● Transfer Function: The basic and most obvious function of the foreign exchange market

is to transfer funds or foreign currencies from one country to another for settling their

payments. The market converts one’s currency to another.

● Credit Function: The forex provides short-term credit to the importers to facilitate the

smooth flow of goods and services from various countries. The importer can use his

credit to finance foreign purchases.

● Hedging Function: The third function of a foreign exchange market is to hedge foreign

exchange risks. The parties in the foreign exchange are often afraid of the fluctuations in

the exchange rates, which means the price of one currency in terms of another currency.

This might result in a gain or loss to the party concerned.

FEATURES OF FOREX:

● High liquidity: The most prominent foreign exchange market feature is the liquidity of

the market. This is possible because of the market's size and geographical spread. This is

an important feature of the market for participants as it means that trades can be executed

at any time. With high liquidity also comes ease of entry and exit in a market which

traders also find very important.

● Market transparency: The foreign exchange market features high information

efficiency. With transactions on the market being recorded electronically and information

updated very quickly across the market it is considered to be both very efficient and

transparent.
 ● Dynamic market: The foreign exchange market is considered dynamic because it

provides a myriad of opportunities to earn a profit. This feature of the foreign exchange

market is one of the key reasons the market is so large because this factor opens it up to

many more market participants.

● Operates 24 hours: There is trading going on within the foreign currency market at any

given time as there is always a need for its services.

● Lower trading Cost: The foreign exchange market features low trading costs because it

does not have restrictive barriers to entry or high fees p[laced on transacting by brokers.

With very small percentages being charged for transactions participants can utilize more

of their money in trades and this foreign exchange market feature makes it favorable for

small participants which widen the market even more.

● Dollar Most Widely Traded: The US dollar is the most widely traded currency in the

world and many currencies calculate rates for other currencies through the corresponding

US dollar value also known as cross rate.

PLAYERS IN THE FOREX MARKET:

● Commercial Banks: Large commercial banks are eminently the most significant players

in the forex market. They contribute the largest amount of capital traded in the forex

markets. Commercial banks profit extensively from this requirement by trading the forex

markets with the funds entrusted to them and generating returns in interest for their

clients.
 ● Central Banks: Central banks, which represent their nation's government, are extremely

important players in the forex market. Central banks are often known as liquidity

providers. They provide different currencies to be exchanged by commercial banks.

● Foreign Exchange Brokers: Foreign exchange brokers also operate in the international

currency market. They act as agents who facilitate trading between dealers. They bridge

the gap between the individual and the forex markets. Hence, they are seen as

intermediary financial service providers that make it easy for individuals to participate in

the forex markets.

● Multinational Corporations: Multinational Corporations in business are companies that

have branches spread across other countries. MNCs act as an umbrella covering various

companies based in different countries, yet they are listed in one country that hosts their

headquarters.

● Individuals and Small Businesses: Individuals and small businesses also use the foreign

exchange market to facilitate the execution of commercial or investment transactions.

The foreign needs of these players are usually small and account for only a fraction of all

foreign exchange transactions.

● Regulators: The regulators are government authorities that regulate the activities of all

the forex market participants, especially brokers. They ensure sanity in the forex markets

and that brokers pay their clients at the end of the day.

STEPS TO TRADE IN FOREX:

1. Learn Forex Trading basics

2. Read a forex quote.

3. Decide the currency to be bought or sold.

4. Learn to calculate profits.

5. Open an Online Forex Brokerage Account: → The first step to opening an online

brokerage account is to research different brokerages. Looking for someone who has been

in the industry for ten years or more and checking to see that the brokerage is regulated

by a major oversight body is a safe option.

→ Request information about opening an

account wherein a personal account or a managed account can be opened. Fill out the

appropriate paperwork and activate the account

6. Analyze the market: → Technical analysis: Technical analysis involves reviewing charts

or historical data to predict how the currency will move based on past events.

→ Fundamental analysis: This type of analysis involves looking at

a country's economic fundamentals and using this information to influence your trading

decisions.

→ Sentiment analysis: This kind of analysis is largely subjective. It

tries to analyze the mood of the market to figure out if it's "bearish" or "bullish."

7. Determine your margin: Depending on the broker's policies, the investor can invest a

little bit of money but still, make big trades.

8. Place an order: Three types of orders could be placed:

→ Market orders: With a market order, the investor instructs his

broker to execute his buy/sell at the current market rate.

→ Limit orders: These orders instruct the broker to execute a trade

at a specific price.
 → Stop orders: A stop order is a choice to buy currency above the

current market price or to sell currency below the current market price to cut losses.

ADVANTAGES OF FOREX:

● High Leverage: A forex investor can avail of the facility of leverage or loan of up to 20

or 30 times his/her capacity, for trading in the forex market.

● International Trade: Every country has its currency and therefore, to facilitate trade

activities between two countries, the forex market is essential.

● Trading Option: For speculators or traders, the foreign exchange market is just like

other financial markets where they can make money on short-term fluctuations in the

currencies.

● Flexibility: We know that the forex market is a twenty-four-seven market, and there is no

minimum or maximum limit on the exchange amount. It provides the flexibility of

investment or exchange to the traders.

● Hedging Risk: The forex market provides for hedging the risk of loss on currency

fluctuations while carrying global business operations and trading in foreign currency.

● Low Transaction Costs: Since brokers are not very much entertained in the forex

market, the transaction cost (called ‘spread’) charged by the dealers is reasonably low if

compared to other financial markets.

● Inflation Control: To maintain the economic stability in the country and control

situations like inflation, the central bank maintains a forex reserve which consists of

currencies of different countries around the world. It adopts other means too, like

decreasing bank lending rates and selling out domestic currency for foreign currency.
DISADVANTAGES OF FOREX:

● Lack of transparency in the Forex market: Due to the existence of intermediaries or

brokers in the Forex market, this market is not completely transparent. This is because,

with a broker, a trader may not have enough power to figure out how to order and trade,

may not know enough about the best offer, or may even have limited views on bids that

are provided only by his chosen broker.

● Complex indicators of price volatility: Price fluctuations in Forex are influenced by

several factors, especially the political or economic factors of the world, which make it

difficult to interpret the data and draw accurate conclusions about trades.

● Increase risk, increase leverage or leverage: It is possible to invest in Forex with high

leverage, and this can lead to trades that may be profitable or unprofitable. Although a

trader can take advantage of leverage, it is also high risk and sometimes even forex

trading can quickly turn into a disastrous catastrophe.

● Self-learning process: In the stock market, an investor can get professional advice from

financial advisors, business analysts, and partnership managers. But in the Forex market,

traders themselves must work hard to acquire knowledge and trading skills; in many

cases, most beginners leave the market during the early stages of Forex trading, mostly

due to losses and insufficient expertise in Forex trading and improper trading.
TYPES OF FOREX:

● Spot forex market: Spot forex markets are also referred to as “physical markets” or

“cash markets” because trades are swapped for the asset effectively immediately. While

the official transfer of funds between the buyer and seller may take time, such as T+2 in

the stock market and most currency transactions, both parties agree to the trade “right

now.” Spot FX is the purchase or sale of forex ‘on the spot’, which means the exchange

takes place at the exact point that the trade is settled. When trading spot forex, you buy

and sell the currency pair at the current market rate, known as the spot price.

● Future forex market: Forex futures are exchange-traded currency derivative contracts

obligating the buyer and seller to transact at a set price and predetermined time. The price

of all futures contracts is based on the underlying asset which, in this instance, will be a

currency instrument.

Forex futures serve two primary purposes as financial instruments:

1. They can be used by companies, or sole proprietors, as a hedging vehicle to

remove the exchange-rate risk inherent in cross-border transactions.

2. They can be used by investors to speculate and profit from currency

exchange-rate fluctuations.

● Forward forex market: A forward market is an over-the-counter marketplace that sets

the price of a financial instrument or asset for future delivery. Forward markets are used

for trading a range of instruments, but the term is primarily used concerning the foreign

exchange market. It's a market where forward contracts are bought and sold for hedging

(investment protection) or speculation (maximizing returns).

 There are 4 types of the forward forex market - Flexible Forward, Closed outright

forward, Non-deliverable forward, and Long dated forward.

DETERMINANTS OF EXCHANGE MARKET:

● Inflation: Inflation is the relative purchasing power of a currency compared to other

currencies. As such, countries with low inflation typically have stronger currencies

compared to those with higher inflation rates.

● Interest Rates: Different countries’ central banks use interest rates to modulate inflation

within the country. Central bankers must consistently adjust interest rates to balance

benefits and drawbacks.

● Public Debt: Most countries finance their budgets using large-scale deficit financing. If

this government debt outpaces economic growth, it can drive up inflation by deterring

foreign investment from entering the country, two factors that can devalue a currency. In

some cases, a government might print money to finance debt, which can also drive up

inflation.

● Economic Health: Economic health or performance is another way exchange rates are

determined. With a stronger economy, the country attracts more foreign investment,

which in turn helps lower inflation and drive up the country’s currency exchange rate.

● Balance of Trade: If a country has a positive balance of trade, it means that its exports

exceed its imports. In such a case, the inflow of foreign currency is higher than the

outflow. When this happens, a country’s foreign exchange reserves grow, helping it lower

interest rates, which stimulates economic growth and bolsters the local currency

exchange rate.
 ● Current Account Deficit: The current account deficit is closely related to the balance of

trade. If a country’s current account deficit is higher than that of a trading partner, this

can weaken its currency relative to that country’s currency. As such, countries that have

positive or low current account deficits tend to have stronger currencies than those with

high deficits.

RISKS INVOLVED IN FOREX:

The three types of foreign exchange risk include transaction risk, economic risk, and

translation risk.

1. Transaction risk is the chance that currency exchange rate fluctuations will change

the value of a foreign transaction after it has been completed but not yet settled.

2. Economic risk is referred to as the risk exposure of an investment made in a

foreign country due to changes in business conditions or adverse effects of

macroeconomic factors.

3. Translation risk is the exchange rate risk associated with companies that deal in

foreign currencies and list foreign assets on their balance sheets.

PREVENTION OF RISK IN FOREX:

● Make Sure You Are Properly Capitalized: Forex trading is a highly risky investment.

However, this is not the right investment for you if you are not properly capitalized.

● Stop Loss Orders: When you use a stop-loss order, this can help you avoid large losses

that could occur when your trade goes against you.

 ● Use Trailing Stop Loss Orders: Trailing stop-loss orders can be defined as a stop-loss

order that is used to reduce the distance between your entry point and your stop loss.

● Use Margin For Long Positions: Margin is a feature that is always present in most forex

trading platforms. This is a great way for you to manage your risks.

● Set a risk-reward ratio: As part of your forex trading plan, you should set your

risk-reward ratio to quantify the worth of a trade.

● Combine Different Strategies: You may have a few different strategies that you can

implement, and it is very important to combine them to get the most out of your trades.

HOW CURRENCIES IN FOREX MARKET ARE QUOTED:

Currencies are always quoted in pairs, such as the U.S. dollar versus the Canadian dollar

(USD/CAD). The first currency is called the base currency, and the second currency is called the

counter or quote currency (base/quote).

FOREX-TERMINOLOGY:

● Currency pair: forex is traded in currency pairs: one currency is bought, and the other is

sold. Together they make up the exchange rate.

● Exchange rate: the rate at which one country’s currency can be exchanged for another

currency.

● Base currency: the currency that comes first in the currency pair (e.g. in GBPUSD the

GBP is the base currency).

 ● Quote currency: the second currency quoted in a currency pair (e.g. in GBPUSD the

quote currency is USD).

● Long position (buy): a long position refers to the purchase of an asset, with the

expectation that its market value is set to rise.

● Short position (sell): a short position refers to the sale of an asset, with the expectation

that its market value is set to fall.

FOREX TRADING STRATEGY:

A forex trading strategy is a technique used by forex traders to determine whether to buy

or sell a currency pair at any given time. The strategies can be based on technical analysis or

fundamental news-based events. There are four main types of forex trading strategies: scalping,

day trading, swing trading, and position trading.

CONCLUSION:

Although a foreign exchange may be confusing, in today’s global marketplace, there is a

critical need for almost everyone to understand foreign exchange like never before. As the world

shrinks, there is an ever-increasing likelihood that we will be required to address the risks

associated with the fact that there are different currencies used all around the world and that

these currencies will have an immediate impact on our world.