How Forex Trading Works

Forex trading involves the trading of one currency for another. It is known by many names, including the "foreign exchange trading market," "FX trading," and "currency exchange." The trades occur between any and/or all of the following participants: 

·         Large and central banks

·         Governments

·         Multinational corporations

·         Other financial markets

·         Currency speculators

According to the worldwide central bank organization, The Bank for International Settlement (BIS), the trade in the global Forex and related markets, on an average daily basis, is over $3 trillion. To put this into perspective, this is more value than the NYSE, the Dow, the S & P 500, and all of the other U.S. stock markets combined! Forex trading is done all over the world, and there is very little to no actual cash changing hands when these transactions are completed. There are several notable differences between Forex trading and stock market trading. The Forex market is in operation around the clock. It opens on Sunday evening and closes on Friday evening. Forex trading takes place across three continents, which allows traders to instantly react to any events or any fresh developments that occur across the globe. The stock market opens for a set number of hours (7:15 A.M. to 5:15 P.M. GMT for the London Stock Exchange) during weekdays. This only allows traders to react to events across the globe during hours of operation. Both competition and electronic trading have resulted in a drastic reduction in the bid-offer spreads, which are equivalent to commissions. The spreads for major stocks can remain low, but often increase when the liquidity of a specified currency falls.

While online stockbrokers have reduced commissions, most consider the Forex market to have the lowest levels of commission in relation to trade size of any financial market. This is partly due to the fact that most trading houses offer 100:1 leverage. This means that a client who puts down a $100,000 deposit can leverage it into $10 million. Another important difference between Forex trading and stock market trading is that retail clients, or individuals, do not have access to almost identical prices as the other participants. There are many different access levels, which result in a range of commission costs or spreads. Only the largest investment banking firms, such as Citi and Deutsche Bank, receive very tiny spreads (i.e. the difference between bidding and asking prices is very small). This is not a well-known fact. It is considered a carefully guarded secret amongst those closely involved in the world of international finance. The further along the trading chain you go, the larger the spreads become. Essentially, the larger the number of trades you make, the smaller the spread is. This is why only the top firms in the Forex market get the smallest spreads. Increasingly larger spreads are provided to small investment banks, major multinational corporate giants, insurance firms, pension funds, and leading retailers. In fact, major retailers were only recently allowed to participate in the Forex market, and they're only allowed to do so through banks or brokers. The value of currency is greatly influenced by many factors, but the Forex market itself is mostly a supply and demand market. If demand rises or if supply falls, prices will rise. On the other hand, prices will fall when demand falls or supply rises. This is the essence of the Forex market and Forex trading.