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Trading in Foreign Exchange: What You Need To Know

The marketplace where foreign currencies are traded is known as the foreign exchange market. Foreign exchange (Forex) is the biggest market in the world where you can trade using platforms like MT4 in Australia, and the deals that take place there impact the cost of everything from Chinese-made apparel to the price of a margarita in Mexico. In April 2021, the Australian market’s combined average daily turnover for all OTC foreign currency instruments was US$139.4 billion.

What Exactly Is Foreign Exchange Trading?

Trading foreign exchange is, at its core, not dissimilar to exchanging money when travelling overseas—buying and selling one currency for another causes the exchange rate to vary frequently due to market forces. The foreign exchange market is a worldwide marketplace where currencies may be exchanged around the clock, Monday through Friday. Since there is no central trading facility for foreign currency, the market is regulated by an international group of banks and other financial organisations.

Most foreign exchange trades between bankers, hedge fund managers, and corporate executives. These investors may be speculating on or hedging against future changes in exchange rates rather than intending to acquire actual ownership of the currencies. Assuming the dollar will grow in value and allow the trader to purchase more euros in the future, the trader may choose to buy US dollars. Meanwhile, suppose an American firm has operations in India and the Indian rupee declines, reducing the value of the firm’s earnings in India. The firm may use the foreign exchange market as a hedge.

How Foreign Exchange Works

Like a stock’s ticker symbol, every currency has its unique three-letter code. While more than 170 currencies are in circulation, the US dollar accounts for a disproportionate share of forex trade, making its three-letter ISO 4217 code particularly useful. The Euro, used by 19 European Union member states, is the second most traded currency in the Foreign Exchange Market.

Forex Trading: Three Approaches

Foreign exchange (FX) transactions are often performed for speculative purposes, similar to stock trading, rather than actual currency conversion. Forex traders, like stock traders, aim to profit from price fluctuations in the foreign exchange market by either acquiring currencies whose values they believe will grow compared to other currencies or selling currencies whose purchasing power they anticipate will decline. For forex traders with diverse objectives, three strategies exist:

  • The spot market:In this principal foreign exchange market, traders buy and sell currency pairings, and exchange rates fluctuate constantly depending on market forces.
  • The futures exchange:To lock in an exchange rate for a certain quantity of currency on a predetermined date in the future, forex dealers may engage in a legally binding (private) contract with another trader.
  • The contracts exchange:In a similar vein, traders may choose a standard contract to buy or sell a certain quantity of currency at a fixed exchange rate on a future date. Unlike in the forwards market, this takes place on an exchange rather than behind closed doors.

Forex traders utilise the forward and futures markets to bet on or protect against future fluctuations in currency prices. The spot market is the biggest of the foreign currency markets and is where most forex deals are performed; hence its activity influences the exchange rates in these other markets. Margin and leverage in forex trading using MT4 in Australia increase the inherent dangers of trading foreign currency; these risks are not present when dealing with other asset classes. Since currency market movements tend to be minor and frequent, traders must employ leverage to make significant bets.