The vast currency market is a foreign concept to the average individual. However, once it is broken down into simple terms, the average individual can begin to understand the foreign exchange market and use it as a serious financial instrument for future investing.
Forex was created not by design, but because traders, brokers, bankers, importers, exporters and investors recognized opportunities it brings. In 1971, the U.S. went off the 'gold standard', in which its foreign exchange rate was pegged to the price of gold. At that moment, new trading opportunities appeared on the horizon.
Forex market is the one stabilizing factor in the world's system of monetary exchange, yet it is not answerable to any extrinsic stabilizing impact. There are "no restrictions" in this market. No single international authority acts as a governing body, and no government can intervene unilaterally to regulate foreign exchange practices or, should there be a threat of world monetary crisis, halt trading. While treasury officials in Washington, London, Bonn, Tokyo and other capitals pay close attention to relative currency values, none can intervene in a regulatory capacity. The market exists only to the extent those traders in Asia (Tokyo, Hong Kong and Singapore), Europe (Frankfurt, London, Paris and Geneva), Bahrain, and the U.S. (New York), New Zealand and Australia (Sydney) are willing to buy and sell.
Foreign Exchange is the simultaneous buying of one currency and selling of another. The foreign exchange market (FOREX) is the largest financial market in the world, with a volume of over $1.5 trillion daily. Unlike other financial markets, the Forex market has no physical location, no central exchange. It operates through an electronic network of banks, corporations and individuals trading one currency for another. The lack of a physical exchange enables the Forex market to operate on a 24-hour basis, spanning from one zone to another in all the major financial centers.
Today, exporters and importers, international portfolio managers, multinational corporations, speculators, day traders, long-term holders and hedge funds all use Forex to pay for goods and services, transact in financial assets or to reduce the risk of currency movements by hedging their exposure in other markets.
Example of Forex trade:
For example, the current bid-ask price for EUR/USD is 1.5775/1.5781 meaning you can buy 1 EUR for 1.5781 dollars. Suppose you see the trend of Euro growing against dollar and feel Euro is undervalued. To execute this strategy you would buy Euros (at the same time selling Dollars) and then wait for the exchange rate to rise.
So you purchase 100,000 Euro (1 lot is Forex = 100,000) selling 157,810 dollars. As you expected the EUR/USD rises to 1.5882/1.5888. Since you bought Euros and sold Dollars in your previous trade you must now sell Euros for Dollars to realize the income. You can now sell 1 Euro for 1.5882 Dollars. When you sell the 100,000 EUR at the current rate you will receive 158820 USD.
Since you originally sold (paid) 157810 USD (158820-157810), your profit is 1010 USD. Your total profit = 1010 USD.
However, if the price falls down to the same amount of 0.0101 (as was the increase from the example above: 1.5882-1.5781=0.0101) or 101 pips (a 'pip' in Forex trading is the smallest tick in the price of a currency). You can lose 1010 dollars from the transaction.
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