If you are interested in the world of investing, you have probably seen the term currency trading more than once, so you may be wondering what the currency market or Forex means and what it is all about.
This practice, which has gained considerable popularity in the last few years, mainly consists of buying and selling currency; you can see the money exchange rate at Rates. Therefore, in this article, you will be able to learn all its details and the principle of operation.
What are Currencies?
As you already know, currency pairs are the local currency and the currency used outside the country of their origin. For example, the US dollar, which is the currency of the United States of America, and the euro, which is official in most countries of the European Union, as well as the pound sterling or the Swiss franc, are considered the currencies of Great Britain and Switzerland, respectively.
The governments of each country are responsible for currency issuance and regulation. They can be exchanged on the world money market. This leads to fluctuations in the price of the currency in relation to other currencies and the existence of exchange rates. However, the exchange rate is fixed, and the central bank responsible for that currency will be the authority responsible for determining its value against another currency.
How is the Forex Market Organized?
The foreign exchange market (or forex, short for foreign currency) is a financial market for buying and selling currencies and is one of the largest in the world by the volume of transactions. The money flow of this market is 7.5 trillion dollars.
If you want to sell a certain currency and buy another, you can access this market through numerous financial institutions, mainly brokers and trading platforms, that exist for this purpose. When you buy one currency, you will pay in the other currency at the current exchange rate.
Imagine you want to buy USD and sell EUR; in this case, you are trading the EUR/USD pair. The first is the base currency, and the second is the quote currency. The exchange rate for this pair indicates how many dollars you would get for one euro.
How to Invest in Currency?
The first thing you need to know is that there are convertible currencies and non-convertible currencies. The first is part of the international currency market, and the second is not accepted in this market. In the next section, we will discuss how to invest in convertible currencies in the Forex market.
All kinds of organizations trade on the Forex market: large corporations, governments, and investment banks. If you are a small investor, you need an intermediary to start investing. Therefore, make sure that the broker you choose complies with all relevant regulations and has a license that allows him to trade in the currency and securities market.
But how do you invest in currency? Here are the financial instruments for this:
- Cash (or spot): A currency exchange transaction is executed at the time of the transaction or within two days later. The stock price is the one set by the market at the moment.
- Financial swaps: an exchange rate that does not necessarily have to be in the market at the time is agreed upon and a date (or dates) is set when the exchange will take place.
- Futures: Futures contracts specify the date and exchange rate of the transaction. However, unlike swaps, these contracts can be sold or bought before expiration.
- ETFs: Although exchange-traded funds are not currencies per se, they are assets that can replicate the movement of a currency or currency pair with the same value, interest rate, etc. So, if you want to trade the US dollar, you can choose an ETF that tracks, for example, the movement of the USDX index.
- Currency options: A contract in which the buyer has the right, but not the obligation, to buy or sell a certain amount of currency at a certain price and within an agreed period of time.
Factors Affecting the Price of Currencies
As with any other financial asset, the price of a currency will depend on supply and demand. However, they are difficult to predict and depend on various factors:
- Interest rate and monetary policy: Both the money supply of a currency and the interest rate set by the central bank will have a large effect on its value. Thus, if more units of a given currency are issued, their value will decrease relative to other currencies (unless they follow the same policy), and vice versa.
- Economic situation and expectations: if economic agents have negative expectations about the results of the country’s economy or if it has a very high budget deficit, investors tend to withdraw their funds from this currency. Therefore, its value will decrease.
- Political situation: The political stability of a country also plays an important role in the value of its currency. Therefore, the more unstable it is, the less investors will trust its currency, so its value will decrease.
- Speculation by large investors: If investment funds or investors with high purchasing power decide to buy or sell a currency en masse to make a large profit, this will affect the price of that currency.
Conclusion
In conclusion, if you have chosen the path of an investor, remember that the key to success is studying the situation. It is not necessary to learn from your own mistakes – you can study other people’s experiences and listen to recommendations, but the main thing is to think with your head and carefully check the information.
If you are not sure of your decisions – do not risk it. Keep this in mind, and you will be able to succeed no matter what type of trading you choose. In addition, no one can prevent you from trying to change the type of activity if it becomes clear that it is not yours.
