How the Forex Market Works

How the Forex Market Works

The financial market is divided into different areas. In addition to the capital market, the money market and the credit market, the foreign exchange market is one of them. It includes both the formation of foreign exchange rates and trading in foreign exchange. Forex market and foreign currency market are other common terms used in the forex market.

Important facts about the foreign exchange market

Unlike some other markets, the foreign exchange market has no fixed seat. Rather, trading takes place in the form of Interbank trading or as over-the-counter trading worldwide. The trading object of the foreign exchange market is always book money in foreign currencies. The exchange participants between whom trading takes place can be banks, large companies, central banks or states. If small businesses or individuals want to buy foreign currency, they have to go through a bank or an exchange office.

In total, there are just over 160 recognized currencies worldwide. Traditionally, the US dollar was the reserve currency, but now it is increasingly sharing this role with the euro.

Forex trading

Currencies are subject to fluctuations, which ensures that their value changes in relation to another currency or the key currency. Investors worldwide benefit from these fluctuations by taking advantage of them. Exactly how trading in foreign currencies works is a complex topic that we are only touching on roughly here. To learn more about active currency trading, the article is recommended Learn to trade with Andre Witzel as well as its informative YouTube videos. As an experienced trader, Witzel does not share theoretically researched, but practice-proven trading knowledge.

The forex market

Foreign exchange trading is also called the forex market or FX market, where forex stands for foreign exchange and thus in turn means trading in foreign currencies. As already mentioned, the values of individual currencies are always about their relationship to another currency. This is because the value of a currency cannot be represented in nominal terms on the international market - it only emerges from a comparison with others. For this reason, forex is traded in pairs.

So instead of buying certain parts of a currency for amount x, you select a forex pair and exchange it according to the current exchange rate.

Exchange rates and volatility

Currencies are traded on the international market for a variety of reasons. For private individuals, the purchase of a foreign currency is very often justified by vacation travel, but in this area too, many people make sure to find the best possible exchange rate for foreign currency purchases:

You usually buy a foreign currency when it compared to the local currency weakens. An example:

On July 23, 2021, buyers of US dollars received 1.18 USD (€ 1 = 1.18$) in exchange for euros. If you wanted to buy euros with US dollars, you only received € 0.85 per 1$.

This is how the exchange rate affects foreign currency purchases

Compared to the US dollar, the euro was stronger that day because buyers received more dollars than they invested euros. On the other hand, investors with US dollars only received a small euro value as equivalent. Anyone who has changed money in preparation for a trip to the USA has made good business.

Returns result from volatility

Anyone who buys foreign currency for private use makes sure that they get as much as possible for their invested money. If you have the opportunity, you should watch the stock market for a few days or weeks in order to buy exactly when your own currency is particularly strong. What travelers do on a small scale is no different from what traders do.

The high volatility of currencies not only enables good purchases and thus the lucrative exchange of currencies, but also high returns by taking advantage of exchange rate fluctuations.

An example:

If you bought 118$ on 07/23/2021 at a market value of € 1 = 1.18$ for € 100, you can invest these dollars again in euros or in another currency at the appropriate time - primarily if the dollar is stronger than at the time of purchase, of course . This is the case when the buyer receives more than € 100 minus the transaction costs for his 118$.

Complex market with potential

More and more investors prefer foreign exchange to stocks or cryptocurrencies. Foreign exchange can be used to generate short-term, medium-term and long-term returns, and small investments are also possible.