What is forex?

Forex (or simply FX) is the short form for Foreign Exchange. Unlike the stock market that runs from NYSE, the forex market is a decentralized (over-the-counter; meaning it does not have to go through an exchange like the NYSE or LSE) financial market that works 24*7 with the exception of weekends.

The primary role of the forex market is to enable international trade and investment, by allowing businesses to convert one currency to another.

Forex market size and liquidity

Most people do not realize that with a daily average turnover of $3.98 trillion dollars, foreign exchange market is the biggest financial market in the world. The breakdown of daily turnover is as follows

  • $1.490 trillion in spot transactions (includes online retail trading).
  • $475 billion in foreign exchange forwards.
  • $1.765 trillion in forex swaps.
  • $43 billion currency swaps.
  • $207 billion in options and other products.

Now, to put it into perspective, New York Stock Exchange (NYSE), the world’s largest stock exchange, had an average daily trading value of $74 billion. In fact, if you add all the stock and future markets in the world, their daily trading value is only one third of forex market combined. Below is a comparison of the Currency Exchange markets with the other major financial markets in the world.

A typical transaction

In a typical foreign exchange transaction, one party buys a quantity of one currency by paying a quantity of another currency. There are always two currencies involved in any transaction. Therefore, currency pairs are traded in forex. For example, when one buys 100 euros by paying 133.23 US dollars, a USD/EUR pair is traded. This is where exchange rates come into the picture.

It is the price of one currency expressed in another. In the USD/EUR example, 1.3323 is the price of euro expressed in US dollars, meaning 1 euro=1.3323 US dollars.

As you can see, buying one currency requires you to sell another currency, and hence each forex trade involves a currency pair, which is explained in more detail in the next lesson.

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