What is Forex?

FOREX the foreign exchange market or currency market or Forex is the market where one currency is traded for another. It is one of the largest markets in the world. Some of the participants in this market are simply seeking to exchange a foreign currency for their own, like multinational corporations which must pay wages and other expenses in different nations than they sell products in. However, a large part of the market is made up of currency traders, who speculate on movements in exchange rates, much like others would speculate on movements of stock prices. Currency traders try to take advantage of even small fluctuations in exchange rates. In the foreign exchange market there is little or no 'inside information'. Exchange rate fluctuations are usually caused by actual monetary flows as well as anticipations on global macroeconomic conditions. Significant news is released publicly so, at least in theory, everyone in the world receives the same news at the same time. Currencies are traded against one another. Each pair of currencies thus constitutes an individual product and is traditionally noted XXX/YYY, where YYY is the ISO 4217 international threeletter code of the currency into which the price of one unit of XXX currency is expressed. For instance, EUR/USD is the price of the euro expressed in US dollars, as in 1 euro = 1.2045 dollar. Unlike stocks and futures exchange, foreign exchange is indeed an interbank, over-the-counter (OTC) market which means there is no single universal exchange for specific currency pair. The foreign exchange market operates 24 hours per day throughout the week between individuals with Forex brokers, brokers with banks, and banks with banks. If the European session is ended the Asian session or US session will start, so all world currencies can be continually in trade. Traders can react to news when it breaks, rather than waiting for the market to open, as is the case with most other markets. Average daily international foreign exchange trading volume was $4.0 trillion in April 2010 according to the BIS triennial report. Like any market there is a bid/offer spread (difference between buying price and selling price). On major currency crosses, the difference between the price at which a market maker will sell ("ask", or "offer") to a wholesale customer and the price at which the same market-maker will buy ("bid") from the same wholesale customer is minimal, usually only 1 or 2 pips. In the EUR/USD price of 1.4238 a pip would be the '8' at the end. So the bid/ask quote of EUR/USD might be 1.4238/1.4239. This, of course, does not apply to retail customers. Most individual currency speculators will trade using a broker which will typically have a spread marked up to say 3-20 pips (so in our example 1.4237/1.4239 or 1.423/1.425). The broker will give their clients often huge amounts of margin, thereby facilitating clients spending more money on the bid/ask spread. The brokers are not regulated by the U.S. Securities and Exchange Commission (since they do not sell

securities), so they are not bound by the same margin limits as stock brokerages. They do not typically charge margin interest, however since currency trades must be settled in 2 days, they will "resettle" open positions (again collecting the bid/ask spread). Individual currency speculators can work during the day and trade in the evenings, taking advantage of the market's 24 hours long trading day.
FUNCTIONS:

The foreign currency exchange markets are where money from different countries are bought and sold. The focus of foreign currency exchange is the facilitation of international commerce. Foreign currency exchange markets can also function as a method of making investments, can be used by governments to impact the value of their currency and can help companies reduce losses due to changes in exchange rates.

1. Primary Function
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The primary function of foreign currency exchange markets is to convert the currency of one country into another currency. For example, the U.S. dollar may be changed into Mexican Pesos or English Pounds. The amount of currency converted depends on the exchange rate, which can be fixed or can fluctuate. The U.S. dollar is a currency that has a fluctuating exchange rate that is based on market demand. Some countries, like China, have a fixed exchange rate determined by their central bank.

International Transactions
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Foreign currency exchange markets serve to facilitate international financial transactions. These transactions may be the purchasing and selling of goods, direct investment in buildings and equipment in a foreign country or the purchase of investment vehicles like foreign bonds. For example, a U.S.-based company may want to purchase goods manufactured in China. The foreign currency exchange market allows them to exchange U.S. dollars and make the purchase in Chinese RMB (renminbi, the currency of the People's Republic of China).

Currency Value
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The value of a country's currency can influence international trade, consumers' purchasing power and inflation. Central banks of a county or region, like the U.S. Federal Reserve, seek to minimize the impact of currency fluctuations. The foreign currency exchange market functions as a tool for central banks to control the value of their currency by buying or selling currency, which influences the total amount in worldwide circulation.

Investment
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Fund managers and investment professionals use the foreign currency exchange market to help diversify their portfolios and potentially increase their returns. Through calculated risks, investors can bet on a change in the price or exchange rate of a currency. Just like with the stocks, if currency is purchased at a low price and sold at a higher price, the investor makes money.

Loss Protection
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International companies that work in multiple countries are subject to gains and losses based on exchange rate fluctuations. To help prevent losses, companies can make forward transactions where they make a binding agreement to exchange currency for another currency at a fixed rate. This function of the foreign currency exchange market helps a company minimize the risk of foreign exchange on future expenses. For example, if a U.S.-based company places an order with a firm in Taiwan that will be ready in five months, the company can enter a forward transaction agreement that fixes the price based on the current exchange rate at the time of order. The company knows the value and cost of the purchase and will not be hit with a future loss based on a change in exchange rates.