If the price increases to 1. In the forex market, currencies trade in lots , called micro, mini, and standard lots. A micro lot is 1, worth of a given currency, a mini lot is 10,, and a standard lot is , Trades take place in set blocks of currency. For example, a trader can exchange seven micro lots 7, , three mini lots 30, , or 75 standard lots 7,, Trading volume in the forex market is generally very large.
Historically, foreign exchange market participation was for governments, large companies, and hedge funds. In today's world, trading currencies is as easy as a click of a mouse and accessibility is not an issue. Many investment companies allow individuals to open accounts and trade currencies through their platforms.
This is not like a trip to a foreign exchange kiosk. The process is entirely electronic with no physical exchange of money from one hand to another. Rather, traders are taking a position in a specific currency in the hope that there will be some upward movement and strength in the currency that they're buying or weakness if they're selling so that they can make a profit.
Forex Market vs. Other Markets There are some fundamental differences between foreign exchange and other markets. First of all, there are fewer rules, which means investors aren't held to strict standards or regulations like those in the stock, futures, and options markets. There are no clearing houses and no central bodies that oversee the forex market. Second, since trades don't take place on a traditional exchange, there are fewer fees or commissions like those on other markets.
Next, there's no cutoff as to when you can and cannot trade. Because the market is open 24 hours a day, you can trade at any time. Finally, because it's such a liquid market, you can get in and out whenever you want and you can buy as much currency as you can afford. Types of Forex Transactions Forex traders transact in one of three distinct marketplaces: the spot, the forward, or the futures market. The spot rate is the current exchange rate. A transaction in the spot market is an agreement to trade one currency for another currency at the prevailing spot rate.
Spot transactions for most currencies are finalized in two business days. The major exception is the U. The price is established on the trade date, but money is exchanged on the value date. Role of the U. Dollar The U. Trading pairs that do not include the dollar are referred to as crosses.
The most common crosses are the euro versus the pound and the euro versus the yen. The spot market can be very volatile. Movement in the short term is dominated by technical trading, which bases trading decisions on a currency's direction and speed of movement. Longer-term changes in a currency's value are driven by fundamental factors such as a nation's interest rates and economic growth. The Forex Forward Market A forward trade is any trade that settles further in the future than a spot transaction.
The forward price is a combination of the spot rate plus or minus forward points that represent the interest rate differential between the two currencies. Most forward trades have a maturity of less than a year in the future but a longer term is possible. As in the spot market, the price is set on the transaction date but money is exchanged on the maturity date. A forward contract is tailor-made to the requirements of the counterparties.
They can be for any amount and settle on any date that is not a weekend or holiday in one of the countries. Forex Futures Unlike the rest of the foreign exchange market, forex futures are traded on an established exchange, primarily the Chicago Mercantile Exchange. Forex futures are derivative contracts in which a buyer and a seller agree to a transaction at a set date and price.
This type of transaction is often used by companies that do much of their business abroad and therefore want to hedge against a severe hit from currency fluctuations. It also is subject to speculative trading. For shorter time frames less than a few days , algorithms can be devised to predict prices. It is understood from the above models that many macroeconomic factors affect the exchange rates and in the end currency prices are a result of dual forces of supply and demand.
The world's currency markets can be viewed as a huge melting pot: in a large and ever-changing mix of current events, supply and demand factors are constantly shifting, and the price of one currency in relation to another shifts accordingly. No other market encompasses and distills as much of what is going on in the world at any given time as foreign exchange.
These elements generally fall into three categories: economic factors, political conditions, and market psychology. Economic factors Economic factors include: a economic policy, disseminated by government agencies and central banks, b economic conditions, generally revealed through economic reports, and other economic indicators.
Government budget deficits or surpluses: The market usually reacts negatively to widening government budget deficits , and positively to narrowing budget deficits. The impact is reflected in the value of a country's currency. Balance of trade levels and trends: The trade flow between countries illustrates the demand for goods and services, which in turn indicates demand for a country's currency to conduct trade. Surpluses and deficits in trade of goods and services reflect the competitiveness of a nation's economy.
For example, trade deficits may have a negative impact on a nation's currency. Inflation levels and trends: Typically a currency will lose value if there is a high level of inflation in the country or if inflation levels are perceived to be rising. This is because inflation erodes purchasing power , thus demand, for that particular currency. However, a currency may sometimes strengthen when inflation rises because of expectations that the central bank will raise short-term interest rates to combat rising inflation.
Economic growth and health: Reports such as GDP, employment levels, retail sales, capacity utilization and others, detail the levels of a country's economic growth and health. Generally, the more healthy and robust a country's economy, the better its currency will perform, and the more demand for it there will be. Productivity of an economy: Increasing productivity in an economy should positively influence the value of its currency.
Its effects are more prominent if the increase is in the traded sector. All exchange rates are susceptible to political instability and anticipations about the new ruling party. Political upheaval and instability can have a negative impact on a nation's economy. For example, destabilization of coalition governments in Pakistan and Thailand can negatively affect the value of their currencies. Similarly, in a country experiencing financial difficulties, the rise of a political faction that is perceived to be fiscally responsible can have the opposite effect.
Market psychology Market psychology and trader perceptions influence the foreign exchange market in a variety of ways: Flights to quality: Unsettling international events can lead to a " flight-to-quality ", a type of capital flight whereby investors move their assets to a perceived " safe haven ". There will be a greater demand, thus a higher price, for currencies perceived as stronger over their relatively weaker counterparts.
The US dollar, Swiss franc and gold have been traditional safe havens during times of political or economic uncertainty. Although currencies do not have an annual growing season like physical commodities, business cycles do make themselves felt. Cycle analysis looks at longer-term price trends that may rise from economic or political trends. It is the tendency for the price of a currency to reflect the impact of a particular action before it occurs and, when the anticipated event comes to pass, react in exactly the opposite direction.
This may also be referred to as a market being "oversold" or "overbought". Economic numbers: While economic numbers can certainly reflect economic policy, some reports and numbers take on a talisman-like effect: the number itself becomes important to market psychology and may have an immediate impact on short-term market moves. In recent years, for example, money supply, employment, trade balance figures and inflation numbers have all taken turns in the spotlight.
Many traders study price charts in order to identify such patterns. Spot trading is one of the most common types of forex trading. Often, a forex broker will charge a small fee to the client to roll-over the expiring transaction into a new identical transaction for a continuation of the trade. This roll-over fee is known as the "swap" fee. Forward See also: Forward contract One way to deal with the foreign exchange risk is to engage in a forward transaction.
In this transaction, money does not actually change hands until some agreed upon future date.
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