Forex, or FX, is an abbreviation of foreign exchange, and refers to the practice of trading one currency for another. The forex market is the biggest financial market in the world, with an average daily trading volume in excess of $4 trillion USD. To put things in perspective, the average daily trading volume of the New York Stock Exchange is around $74bn.
If you’ve ever bought foreign notes for an overseas holiday, then you will have participated in the forex market, albeit on a very basic level. Let’s say, for example, that you were travelling to the US from the UK, and were exchanging pounds for dollars. The amount of dollars that you receive is based on the exchange rate between the two currencies multiplied by the amount of currency that you are trading. So, if the exchange rate was 1.5, and you exchanged 100GBP, you would get 150 USD in return. You might get charged a commission on this, but we’ll forget about this for the time being. Anyway, here is the equation.
Amount of currency 1 x Exchange rate = Amount of currency 2
100 GBP x 1.5 = 150 USD
In the unlikely event that you didn’t spend your 150 dollars while you were in the states, you could change it back into pounds when you get back. The chances are, however, that by the time you get back to the UK, the exchange rate will have moved. Let’s say it’s moved to 1.4 – quite a big swing by ordinary standards, but it will do for the purpose of our demonstration. The rate is a result of the changing relative values of each currency, which are determined by the laws of supply and demand. The amount in pounds that you receive when you trade in your dollars at this exchange rate will be the amount in dollars divided by the exchange rate. Here is the equation:
Amount of currency 2 / Exchange rate = Amount of currency 1
150 USD / 1.4 = 107 GBP
As you can see, you are now up by seven pounds. Congratulations! You are now a successful forex trader! If only you had exchanged a thousand pounds instead….
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