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Trading currency (FX) Overview
FX, Foreign exchange or forex are all descriptions for trading currencies. Over USD 1.5 trillion is traded everyday making it the largest market in the world. Approximately 80% of all trades are speculative rather than for reasons of necessity. This volume has added to its volatility and therefore its appeal.
Rather than having central exchanges as you might find for stocks and shares there is an 'interbank market' which is an OTC (over the counter) market. Prices are agreed between two parties by phone or over the net and the market is a 24 hour market.
In essence a currency trade is an agreement between one party to sell one currency and another to buy it at an agreed rate of exchange using a different currency. The combination of currencies is known as a 'cross currency' and the most common are EUR/USD , USD/JPY , GBP/USD and USD/CHF.
Purchase (buy) / Sell foreign currency
Usually currencies are bought/sold on the basis of 'spot' settlement - i.e. for payment in 2 days. However you can also buy a 'Forward Contract' whereby both parties agree to settle the trade on a date in the future. The exchange rate will be modified from the 'spot rate' to take into account interest rate differentials. In plain English this means that if the interest rate in one country is different to that in the other country there will have to be an adjustment to the exchange rate. For example if interest rates in the US are higher than those in the UK and you are selling GBP to buy USD then you will have an improved exchange rate. The further 'Forward' you buy the 'better' the rate. Conversely if you were selling GBP to buy EURO then the exchange rate would be worse if the interest rates were less in the Eurozone. The reason is that if you had an amount of GBP you would prefer it to be in USD as you will get a better interest rate.
Forex Trading allows the investor to trade on margin which means that you can buy and sell assets that represent better value than the actual capital you have. In effect you are putting down a deposit to buy or sell a larger amount of currency. Therefore your returns and risks are higher
A simple guide to fx trading may be viewed by clicking here. Currencies can be traded online from anywhere in the world.