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I’ve had this question come up a few times and figure I would spend a few posts over the next couple of months to talk about it. The big question I’ve been getting lately, that deserves a big answer, is about the Forex markets. So this post will serve as the definition and we might talk a bit about the spot market.
Forex is the abbreviation of the name given to the foreign exchange market. It’s the market that has to do with buying and selling a country’s currency. Forex is important because it’s how international countries all over the world conduct trade. Believe it or not, there are some countries and businesses that do not accept the dollar as preferred method of payment. What the NASDAQ, DOW, and S&P 500 are to equities; Forex is to currencies and all the trading happens electronically. This currency market is open 24 hours a day, 7 days a week, 365 days a year and trade happens where ever there is an internet connection and in centralized spots in major metropolises all over the world.
What’s the big deal about trading currencies? I can do that at the bank is what you might be thinking to yourself at this point. While you can buy and sell foreign currencies at your local bank it’s not the same as transacting in this market. At the bank you are either paying a premium or selling at a discount for your international currencies and it’s a cost associated with the bank having to turn that back into Dollars; banks don’t offer services for free. Forex trading sites are great because they are electronic brokers, kind of like your E-Trade for currency. While there are transaction costs associated with trading, the currency acts as a commodity so the values are dictated by market forces not what banks are willing to give you.
The Spot Market is where prices are decided in real time for currencies all over the world, it’s considered the present value market. You use a broker like finexo.com and when you buy and sell Dollars for Euros you’re doing it in real time and deciding real time prices for each. Like any other commodity prices for currencies are subject to supply and demand forces, interest rates, and economic performance (locally, internationally, and in relation to the trading currency). What makes it even more interesting is that you have to factor in risks like political stability and possible future performance of the currency. A country with political turmoil or whose government is constantly the victim of a military coup probably won’t have the same kind of reliability as the U.S. with the Dollar. Those factors all affect what party’s are willing to buy and sell a currency for. The spot exchange happens in real time so for a transaction to execute one party gives a specific amount of a currency for a specific amount of another currency. These transactions create spot rates which would be more commonly known as foreign exchange rates.
I know that was a very brief overview of both Forex and the Spot Market but it was designed to get your taste buds ready for what is to come. I hope to have at least provided a foundation to those of you out there who had no idea there was even a market for currencies like this. If you are dying to know more now, I suggest taking a look at Essentials of Foreign Exchange Trading it’s a great “Forex 101” read and Chen does a great job outlining it for you.