An Introduction to the Forex Market

An Introduction to the Forex Market
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The foreign exchange market is relatively new as it is the product of the 20th century. Before that time the foreign exchange market need not exist as most currencies were backed by specie (gold and silver) and could be redeemed for specie then the specie could be converted to the currency of choice by the end user. Today the Forex market is necessary to complete transactions in fiat currency from one to another.

Setting the price

Before the world nations went off the gold and silver standards there was no need to set a value for each currency. Instead the value of the currency was equal only to the amount of gold or silver it could be redeemed for as set by the representing government. Now that most currencies are not backed by metals they must have some kind of value as set by the open market, for instance one US dollar today is worth about .7 Euros. The same one US dollar is also worth about 1/800 of an ounce of gold or about 1/30 of a gram. These prices are now set by the open market instead of governments, giving the free market advantage to companies and investors to do with the market whatever they desire.

A decentralized marketplace

Unlike the New York Stock Exchange or NASDAQ there is no set place to trade currency. There are many banks, known as interbanks, which process trades between one currency to another. This decentralized market allows for 24/7 trading and huge amounts of liquidity throughout the day.

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The biggest market in the world

It should come to no surprise that the biggest market in the world by value would be the foreign exchange market, the market where money is literally bought and sold. It does not take a genius to realize why the foreign exchange market is so valuable, buying and selling currency is big business. Today approximately $3.2 Trillion changes hands each day on the forex market with the volume of currency growing quickly. As more currency is created by governments and central banks, it is only natural that more and more money will be bought and sold on the foreign exchange market.

Where does all this money come from

The volume on the forex market comes from a variety of sources. When a foreign company buys another company in another country, that is considered a forex trade. A set amount of currency is traded for the hard assets of another company. Also, governments and institutions swap debt and cash equivalent securities such as treasuries in the US or corporate bonds from Germany for cash, also resulting in a forex trade. Going down the list by volume the next biggest would be the exchange of cash by corporations. For example, McDonald’s is headquartered in the United States but does business in tens of countries around the world. As such its accounts are kept in the United States so any profits from overseas must be converted to the US dollar before being reported. Finally the least amount of volume comes from speculation, or the buying and selling of currency for a profit.

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