Replaced by the barter system, the currency is the main tool of how one can buy goods and services in a state. Every recognized state, whether de-facto or de-jure has its currency recognized in the international market. Matter of the fact is that some currencies are more valuable, expensive and have wide demand in the international market while the others are not in much demand. The demand and supply of the currencies also depend on the social, political, demographic, geographic conditions of the state. While economic stability positively affects the position of the currency of a state in the international foreign exchange trading market.
Forex trading abbreviated as FX is the trading of currency with the other. Generally, money exchangers buy the currency of a state at the rate of its international exchange rate and then sell it to the demand. People buy it before going to certain states or because of being in a foreign exchange trading business. The business is highly profitable yet risky because if suddenly due to any clash, situation, failure of diplomacy, etc. the value of a currency is down, the person who bought currency at a high price is in loss unless the currency rate is raised again either to the previous level or even above that. Forex market is the international network of markets connected via brokers, institutions and individual dealers (not common in the very start) and banks, etc. used for trading foreign currency in exchange for the other.
How does forex trading work?
ESSENTIALS OF FOREIGN EXCHANGE
foreign exchange rates fluctuating factors
- The economic factors that may bring the value of currency upwards or downwards are listed below
- Central banks set the interest rates in a state in foreign exchange; This is as important in the Forex market as in trade, investment, buying or selling something inside the state is. The higher interest rate generally brings more foreign direct investment (FDI) which ultimately raises exchange rates as well.
- Inflation if increases, decreases the power of purchase for a state. Its increase decreases the exchange rate of a currency as well. The lower the inflation is, the higher the exchange rate of a currency is.
- Trade volume and its type (import and exports) set the rate of the currency; This means the preference of a state to either higher the volume of imports or exports. Generally, the more the country export, the more people buy its currency hence raising the value of the currency. Moreover, developed states or otherwise states, if they want to rise economically focus more towards exports to gain more relevant foreign reserves.
- Political stability highly can fluctuate the currency exchange rate of a state. If there is any war, proxy war, elections, etc. leading towards political instability may lower down the price of a currency; This, however, is applicable in all types of states whether developed, developing or underdeveloped. While even if the winner of election is a highly appreciated and wanted man by a state, its currency can be of more value than ever before.
- The foreign exchange value rate gets compared in pairs that mean the US dollar is either compared with Euro or Australian/Canadian dollar or any other currency to determine its rate. The rate can constantly increase in the international market or decrease depending on the factors highlighted above. For example, if a person from Pakistan is supposed to buy the US dollar, it will cost him around 150 rupees to buy 1 $US dollar unless the later currency increases its value internationally. The former currency value is decreasing, and the US dollar has increased its value internationally.
- Internationally foreign exchange is done in millions and trillions determined by its volume. The largest foreign exchange centers trading centers are in Britain, USA, Japan, and Singapore, etc. in their relative foreign exchange markets. Market, however, is open 24 hours mostly in 5 standard working days worldwide. Foreign exchange, as already described, is the electronic network and not the physical object where a person can go to fulfill his purpose with regards to currency trading. The electronic network also clarifies the fact that there is no physical exchange f money if a person is buying Euro while being in any of the African states. The system is online, and money transactions hence are online too. Another name for this online system, including trading (buying/selling) is “over the counter transactions (OTC)”. OTC, however, refers to the visual but not physical ownership of the currency. In OTC, people only earn or take the profit or loss depending on the choices one may make.
Types of market
- In foreign exchange, the “spot market” and “forward market” are the two basic terms that are always referred to whenever an exchange is supposed to take place. The spot rate is set on a trading date while the forward rate is pre-fixed before trading for a certain day while keeping in mind the possible rises in the value of the currency. The widely demanded currency, however, is US dollar while the Canadian dollar, Australian dollar, yen, yuan, Pound and Euros, Riyal, deenar of Kuwait are also among popular demands. The currency exchange business is predictable yet risky for the traders as any ease in monetary policy, the downfall of a government; elections in a state, etc. may affect the value of the currency. While if a trader, intelligently predicting sells currency timely, or buy it at lower rates earns a valuable profit.
Foreign exchange reserves
- At the state level, foreign exchange currency reserves are the assets of the state that can come in handy for the possible devaluation of the currency of any state. To date, China has the largest foreign exchange. Foreign exchange in the banks is in US dollars because of its status of global currency. It is kept in the form of banknotes, deposits, treasury bills, and bonds, etc. the reserves are efficient if the state can pay for its imports and debt payments/installments for a year minimum, in case of crises. The best way to cover up the currency devaluation or avoid any crises is to have Keynesian economic policy working that in general, is more exports than imports.
The most important point here is that the foreign exchange market came into existence after the demolishing of the Breton woods system. Afterward, there were many currencies in the market while before, only the UK pound has the power to turn the tables; This was so because of the hegemonic position of Britain, its imperialistic designs, technological moderation, economic prosperity and political stability there. WWII however, changed the situation for all. Britain itself lost control over many of its areas than gaining independence in the mid of the 20th century. However, since then, with the cold war, USSR and the USA were the power blocs while the USA is winning the situation. Afterward, with the continuous strong position, the US dollar became the global currency and the most valued currency in the world.
Foreign exchange trading is risky for beginners and even for the people having businesses in this field for a long. One wrong decision can have a major loss depending on the type of lots a person/institution or broker is trading in. Forex trading is the official center for foreign exchange trading having online over the counter users. The profit or loss in the exchange trading is taken but not the physical money. Inflation, political stability, trading volume and type, etc. fluctuate the rates of the currency in the international market.