A Beginner’s Guide to the Forex Market
The foreign exchange market, or Forex market for short, is the marketplace of the world’s currencies. While stocks are traded at physical exchanges, Forex is a decentralized market in which currencies are traded during various trading sessions in large financial centers around the world. Sydney, Tokyo, London and New York are the main trading hubs for the Forex market, where billions of dollars’ worth of currencies are traded every single day. In fact, the Forex market is the largest financial market in the world, with an estimated total daily turnover of $5 trillion! This is much larger than the stock and bond market even combined, and the total United States’ GDP is traded in a single trading week in the Forex market.
Who Trades on Forex?
If you’ve ever exchanged your domestic currency for a foreign currency, you’ve already participated in the world’s largest financial market – the forex market. However, the largest market participants are hedge funds, banks and governments. Hedge funds and banks exchange an enormous sum of currencies with each other on a daily basis, and governments hold foreign exchange reserves in order to intervene in the open market and support their domestic currency’s value when it’s appropriate to do so.
Large multinational corporations are another major player in Forex, as they sell their products overseas and repatriate their earnings back to their home country. This involves the buying and selling of substantial amount of currencies in the Forex market.
In the recent years, the retail Forex sector has experienced a significant growth and now accounts for around 5%, or around $250 billion of the daily Forex turnover. Retail Forex is where you and I can trade on the changes in the currencies’ exchange rates. Simply said, a retail Forex trader wants to buy a currency cheap and sell it later at a higher price, but there is also a possibility to profit on falling prices in the Forex market by short-selling a currency pair.
However, as currencies usually fluctuate around 1% daily, most retail traders have to use leverage in their trading to increase their exposure to the market and the potential profit. The Forex market is famous for its high leverage compared to the stock market for example, which in turn attracts more and more traders to trade currencies.
What are the Major Currencies in Forex?
There are many currencies in the world, in fact 180 different currencies as recognized by the United Nations. However, not all currencies are equally trade on the Forex market. Naturally, the world’s most developed nations make up the largest share of the global trade volume and their currencies are the most heavily traded currencies in the market.
Those involve the US dollar (USD), euro (EUR), British pound (GBP), Japanese yen (JPY), Swiss franc (CHF), Canadian dollar (CAD), Australian dollar (AUD) and the New Zealand dollar (NZD). If we expand this definition further and include all G10 countries, then the Swedish koruna (SEK) and the Norwegian koruna (NOK) are also part of the most traded currencies in the world.
Among all these currencies, the US dollar accounts for the majority of the total transacted volume and is part of around 87% of all traded currency pairs as either the base currency or the counter-currency. The other currencies in the Top 5 are the euro, Japanese yen, British pound and Australian dollar, as shown on the following graph from the Bank of International Settlements.
Now that you know what the Forex market is about and what are the most traded currencies, it’s time to see how retail traders analyze the market in order to make a profit from exchange rate fluctuations.
How to Analyze the Forex Market?
A large number of factors can impact the price of currencies, and market participants (including retail traders) try to anticipate the rise or fall of a currency’s exchange rate by analyzing the Forex market. The notable exception are corporations and governments, which don’t participate directly to make a profit on currency fluctuations.
The main types of analysis in the Forex market include fundamental, technical and sentiment analysis.
Fundamental analysis involves the research of fundamental factors that affect the value of currencies, in order to get to the intrinsic value of a currency. This includes the analyzing of economic conditions, interest rate differentials, retail sales and labor conditions to name a few, which all can change the underlying supply and demand for a currency and its respective exchange rate against other currencies. Fundamental analysis is best suited for long-term Forex traders, as currencies tend to differ from their fundamental value to a large extent on shorter timeframes.
To bridge this gap of longer-term fundamental trading, traders turned to technical and sentiment analysis which have shown to return better results in the short-term.
Technical analysis includes the studying of the currency pairs price-chart, in order to find repeatable patterns which can be used to anticipate the future price movement. The Forex market is a particularly rewarding financial market for technical analysis, as currencies have a natural tendency to trend both in the short-term and long-term.
And finally, sentiment analysis involves the research of the current market sentiment towards a currency. Are market participants optimistic or pessimistic about a currency? The sentiment of market participants can have a major impact on the short-term order flows in the market, and disrupt the supply and demand for a currency which in turn is reflected by the change in its exchange rate.
Forex is an exciting market where the world’s currencies are traded in financial centers around the world. The retail Forex industry attracts a growing number of new traders, partly because of the relatively high leverage that is offered by Forex brokers.
Traders try to anticipate the future price movement of a currency, in order to make a profit by buying a currency cheap and selling it later for a higher price. To do so, Forex traders turn to fundamental, technical and sentiment analysis. The trending nature of currencies is a great basis to technically analyze the market and make profitable trading decisions.