If you are new to the idea of trading, or even if you are an established trader but you don’t trade in forex, you may not know exactly what ‘forex’ means and the difference between forex versus stocks. Just what is forex trading? Simply put (although if we’re honest forex isn’t exactly simple when you really drill down into it) forex is a portmanteau of ‘foreign exchange’, and it is the market in which two currencies are exchanged at an exchange range which can be either fixed or floating. Think about when you go on holiday and change your pounds into euros, for example; you’ll see the exchange rate then.
But forex trading isn’t about holidays. It’s about the exchange rate that is used when produce is imported from different countries. So if a merchant in England wants to buy produce from France, he or she will need to exchange their pounds into euros in order to do it. This is how all international trade works.
Forex trading is different to the general stock market because the forex market is decentralised (that is, there is no central trading area). Instead, the majority of foreign exchange transactions are over the counter ones, carried out by banks for their clients.
It may surprise you to discover that forex trading really began back in 1875. This was when the gold standard monetary system was brought in; before this happened, gold and silver were used to buy goods from abroad, and they didn’t need to be exchanged – they held the same value all over the world.
The issue here was that gold’s value changed depending on how much was available. As soon as a new source of gold was discovered, the value of the gold already being used out in the world decreased. This meant that using it to buy items was unsustainable, and so countries started to put their own spin on things, determining how much gold was worth themselves. Since each country did this independently of the next, each country had effectively created its own currency. By the time World War I ended, gold was no longer used, but the exchange rates were still required.
Today, forex – or FX – trading is more accessible than ever. Once only accessed through brokers and banks, now individual traders can access the markets online at any time, and trade when they want to. The forex market is open 24 hours a day, five days a week.
As mentioned above, FX trading is currency exchanged at an agreed price. Those who are trading could be anything from financial institutions to insurance companies, banks to individual traders, and plenty more besides.
Forex trading is always done in pairs; the original currency and what it needs to be exchanged into. An example of this is GBP/EUR. This is made up of GBP (the base currency) and EUR (the quote currency). To own one GBP, you need to have the equivalent amount in EUR.
But how does this relate to trading? To begin with, the goal of forex trading is to work out the direction of the markets – it’s about buying one currency at a low exchange rate and deciding when to sell it at a higher exchange rate.