What Does FOREX Stand for?
FOREX is an acronym that stands for foreign exchange. The term refers to the worldwide currency market where the world's currencies are exchanged every business day. Players in the Forex market may be giant corporations and financial institutions moving money around as part of doing business. However, most of the volume on the Forex market is generated by institutions and individuals who trade currencies for profit with the objective of benefiting from changes in currency exchange rates.
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The Forex Market
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The Forex market is the largest securities market in the world with an average volume exceeding $3 trillion daily. Currencies are always traded in pairs, one against another. Trading is carried out primarily via electronic funds transfer using the Internet and continues 24 hours a day. There is no centralized exchange. The euro, British pound and U.S. dollar are among the most traded currencies along with the Swiss franc and the Australian and Canadian dollars.
History
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After World War II, an international agreement tied currency exchange rates to the US dollar which was in turn based on gold. The goal was to create monetary stability and promote trade, but by 1971 it became clear the system was too rigid. Since then, currencies have "floated." That is, exchange rates are determined by market supply and demand. By the 1980s a thriving currency market developed based mainly on "Eurodollars" (U.S. dollars on deposit in European banks). In the 1990s, the advent of the Internet and electronic funds transfer made physical movement of currency unnecessary and allowed average people to trade currencies. The result was an explosive growth in volume and the evolution of today's Forex market.
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How Trades Work
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Suppose you see a Forex price quote that looks like this: EUR/USD 1.2500. The first currency (here the euro) is the base currency and is always equal to 1. The number "1.2500" means it takes 1.2500 units of the second currency (here the U.S. dollar) to buy one unit of the base currency. If you want to trade currency, you might buy a lot of euros with U.S. dollars at an exchange rate of 1.2500. If the exchange rate changes to EUR/USD 1.2600, you can sell the euros back to your Forex broker for 1.26 dollars per euro, making a profit of 1 cent per euro. Of course, if the exchange rate shifts the other way, you lose money.
Considerations
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Forex trading is high-risk. This is because trades are made with very low margins. It is routine for a trader to put up less than 1 percent of the total value to buy $100,000 lots of foreign currency. Even tiny shifts in currency exchange rates mean large profits or losses. Before you try to trade currency, study the market and get some experience with a practice account. Forex brokers offer practice accounts free to attract new clients. In addition to the market risks, you have to be careful to deal only with reputable brokers. The Securities and Exchange Commission warns that there are many fraudulent websites online. A good rule of thumb is to look for a Forex broker that is a member in good standing of the National Futures Association, which serves as an industry self-regulating organization.
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