The forex market is one of the most unique markets in the world. Unlike the stock exchange, the forex market is open 24x7x365. What is even more surprising about the forex market is that the market is not strongly regulated, which basically means it is up to the forex dealers if they wish to join their country’s regulatory authority or not. The forex market is not run by any single country and it not influenced by any single government. If you have no idea what the term foreign exchange rate means and how the exchange rate should be interpreted, here is a quick primer.
Foreign exchange rates are what it costs to exchange one country’s currency for another country’s currency. This is why the foreign exchange rates are always represented in pairs, for example the foreign exchange rate of the dollar to the pound is represented as USD/GBP. Every currency in the world is assigned a unique 3 letter currency code. Contrary to popular belief, you will never get the exchange rate mentioned in the newspapers because each bank and forex dealer makes money on transactions by manipulating the exchange rate.
Forex is represented as currency pairs and the trading rates are also displayed in pairs. For example, a GBP/USD spread of 1.21/1.24 means that you can sell one Pound for $1.21 and buy one Pound for $1.24. This means that if you have £100 you can sell it to a forex dealer to get $121 and you will have to pay $124 to buy £100. It is important to note that the exchange rate being offered is entirely up to the forex dealer, and you (the trader) have to rely on the forex dealer’s integrity to give you the correct exchange rate. In the above example, the Pound is referred to as the Base currency and the US dollar is the quote currency.
Forex dealers make money in two ways, by increasing the spread or by charging commission on each transaction. For example, if a forex dealer buys £100 for $110 he can then sell the £100 to a forex trader for $120, thus making a profit of $10. As mentioned earlier, there is no strict regulatory committee and it is entirely up to the dealer how much profit he wants to make. In addition, a forex dealer can also choose to charge a transaction fee on each transaction. In either case, exchange rates are entirely up to the forex dealer.
Forex traders can choose to buy a certain currency and then wait till they receive a favourable sell rate. For example, a forex trader can buy £100 for $125 and then wait till he gets a favourable exchange rate, and then sell the £100 for $140. Forex traders also indulge in a practice known as “offsetting”, a forex trader can choose to buy and sell a currency at the same time thus making sure that any loss incurred in buying the currency will be made up for by selling the currency.
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