It is hard to imagine our modern global economy without foreign exchange or forex trading. A quick look around your house, workplace and schools would reveal products imported from another foreign country—all paid for with currency that’s traded on the forex market.
Why Forex Is Vital To World Trade
Forex trading is basically the conversion of one currency to another at a set price. Forex trade is vital to the economic health of any country or business and the reason for this is that one needs to convert a locally issued currency in order to pay for goods and services offered for sale by another country.
While governments of different countries issue their own national currencies for commercial and trade purposes in their respective territories, not all of these currencies accepted as a medium of exchange by the rest of the world. Because all countries and their citizens need vital resources such as oil, machinery and finished goods as well as services from each other, one needs to buy or trade their local currency to an accepted medium of exchange to pay for their imports.
The Forex Market
Given the importance of forex trading to the world’s economy, it is no wonder that it is considered as the largest financial market in the world. It is estimated that about $4 trillion worth of currencies are bought and sold every trading day.
The best way to understand forex trade is to think of the forex trading system as one huge dictionary that translates each words or local currency to another country’s terms or currency value. However, unlike a dictionary where the meaning of word stays or less constant, the value of a specific currency changes each day depending on the different economic and political factors that influence price movements.
Unlike the equities, oil, commodities and futures markets, the forex market doesn’t have any centralized exchange or trading center and instead all transactions are done over the counter (OTC). Trading is done practically on a 24-hour basis as one can trade in forex in other parts of the globe with different time zones.
How Forex Trade Works
Trading in the forex market is quite basic. All currency is done in pairs because one needs to convert a specific currency to another. Each currency has a set value or price and this can be exchanged for another based also on the other currency’s pricing. For instance, let’s say you want to trade 100 Australian dollars (USD) for corresponding US dollars (USD) where the value of the AUD is 0.90 to USD 1. The trade or conversion will be USD $110 for every AUD 100. This means for every US$, you paid AUD 0.90.
Forex Market and The Financial Markets
Because most trades on various financial markets are done across national borders, forex trading has become more and more critical to the health of these markets. To illustrate:
Oil Trades – All countries need oil to keep their industries and economies running. To pay for all these oil bills, companies and governments need to purchase the most accepted currency to ensure their petroleum purchases and deliveries are consummated promptly. Traders who bet on oil price engage in forex trade to convert their currencies to dollars and other acceptable currencies.
Stock markets/Equities – Investors and traders across the globe who buy and sell equities all have to trade their currency holding with forex brokers and dealers to pay for their investments. Many investors take advantage of currency price movements to purchase or sell their stock / equity holdings as it adds more to their profit margins. For example, if the US Dollar drops in value, that would make the stock prices relatively cheaper.