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NO02 - What Is Traded In Forex?

"In the previous article/unit we explained the basics of forex. That forms the fundamental basis in your journey to understanding the currency markets. By now, you have already gained the knowledge of what is the forex markets all about and how it comes to other markets. While the previous article gives you a foothold into the currency markets, we take a notch further in this article. Here, we explore the concepts of what securities or instruments are traded in the markets. You will learn the basic elements of what is involved in trading the currency markets. By the end of this article, you will have a good understanding of the instruments that are traded in the forex markets. This will give you a good base as we move to the next level of learning what forex trading is all about. This article gives you a taste of the things to come and what you can expect to see in the forex markets."

The forex markets as you have learned in the previous chapter deals with currencies. Therefore, it should be a no-brainer to understand that currencies are traded in the forex markets.

Because currencies tend to fluctuate in value against one another, the prices constantly change all the time. This gives traders such as you, the opportunity to trade these changes in the currency values.

As you might have guessed by now, trading forex is all about speculating whether one currency will rise in value or fall in value to another currency. At the very core of the forex markets, is the exchange rate.


What is an exchange rate?

An exchange rate in the forex markets, as the name signifies is the rate at which you can exchange one currency for another. This is rate at which you can sell your domestic currency to buy a foreign currency or vice versa.

But you might be wondering how these exchange rates are set.

The exchange rates in the forex markets are determined by the open markets. The open markets are a collective group, made up of companies, banks and general people like you who have the need to transact in various currencies.

The currencies of many of the world’s leading economies are free floating exchange rates. Of course, you also have currencies that are pegged or trade at a fixed exchange rate.

You might already know that the world’s reserve currency is the US dollar. It is a free-floating currency, meaning that the exchange rate for the US dollar can change. For example, the rate of the US dollar can vary when you exchange it with euro and it can be a different rate when you exchange it with the Japanese yen.

What determines these different rates is basically the study of the forex markets.

To illustrate this with an example, let’s say that you see that the exchange rate for the EUR/USD is 1.1200. What this means is that you can exchange one euro and get 1.120 dollars.

So, when you think that the euro will rise in value against the dollar (ex: EUR/USD= 1.1400), then you would obviously, buy the euro at $1.120 and sell it when the exchange rate reaches $1.140.

This gives you a profit of $0.20.

Now $0.20 might seem insignificant. In the next section of this article, we will lightly touch upon leverage and how profits are made in the forex markets.


Why do we need the forex markets?

The forex markets are important for an efficient functioning of the economy. Every economy is different and if it is one where the currency is a free-floating exchange rate, then there are a number of factors that determine its rate.

The general rule of thumb is that when there is more demand for a currency, its value tends to rise. Conversely, when there is less demand for a currency, its value falls.

What determines the supply and demand for the currencies depends on a lot of factors. But at the core is the central bank. The central bank adjusts its monetary policy to ensure that there is growth and stability.

The central bank can achieve this by either supplying the domestic market with more money or by removing money from the economy.

When supply of the currency is short, the value obviously increases. Likewise, when the supply increases, its value falls.

Because the currency markets fluctuate, the forex markets form an essential element in the global economy as they help companies, people and the country itself to transact in global or different currencies.


How can you trade the forex markets?

You can participate in the forex markets by firstly opening a forex trading account with your forex broker. The forex broker is the entry point for you in the forex markets. They connect you to the currency markets and allow you trade.

Of course, to make a profit in trading the forex markets, you need to have some capital to trade. But it is not just the deposits required but also leverage. Leverage allows you to magnify your capital in order to make profits in the currency markets.

The currencies as you know, do not change sharply. Rather there are small movements which is even smaller than cents that you are used to in your day to day life. In order to profit from these small movements, leverage is used by traders.

Traders can then choose to buy one currency and sell the other or sell one currency and buy the other. This is nothing but trading in the forex markets.

To be able to make a profit by trading forex, you will need to have a good understanding of two main fields of study.

These are known as fundamental analysis and technical analysis.

Don’t let the technical jargon confuse or discourage you at this point. We will gradually touch upon these in the later sections of this forex education.

Read 1035 times Last modified on Friday, 03 May 2019 11:17

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