Forex: what is it? Why Invest?

What is forex?

Created in 1971, Forex is a decentralized international market where all world currencies are traded. It is a counter place open 24 hours a day from Sunday evening to Friday evening. More than $ 5 trillion is traded every day.

On Forex it is possible to buy (bid price) and / or sell (asking price) currencies at a price resulting from the comparison between supply and demand (floating exchange rate). Trading is carried out through computer networks that connect traders (also called currency traders) via electronic platforms such as that of the American Nex Group.

Unlike stock market activities (stocks, bonds, etc.), currencies are always quoted in pairs. Each currency that makes up the pair is designated by a three-letter code (for example, EUR for the Euro or USD for the US dollar). The value of one currency is always expressed relative to another currency. So we will say that one euro is worth 1.18 dollars. Some of the most traded currencies in Forex include the dollar, euro, British pound, and Japanese yen, all of which are considered reserve currencies by central banks (who store them).

The exchange rate between currencies (equilibrium price) is sensitive to several factors: all economic events (change in interest rates, inflation, growth rate, etc.) as well as political events, market sentiment, natural disasters, etc. .

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How Forex works

There are several players on the foreign exchange market: central banks, commercial banks (and financial institutions), companies, hedge funds and, on the sidelines, some individual investors who play one currency against another through derivative products (CFDs, etc. ).

Thanks to Forex, all these players can trade currency pairs with guaranteed liquidity. Each pair, for example EUR / USD, consists of a reference currency (for example the euro) and a counter currency (for example the dollar). It is the valuation of the reference currency with respect to its counterpart providing the quote.

As in the traditional stock market, when buying a currency, prices rise as demand increases. This phenomenon is particularly evident during times of crisis, when investors flock to safe-haven currencies such as the dollar, yen and Swiss franc.

To notice : the dollar remains the reference safe haven currency. It is the first currency used and traded globally: 85% of transactions made on Forex involve US dollars.

Conversely, each time a currency is sold, its relative value relative to other currencies decreases as supply is greater than demand. Downward movements can be spectacular. Thus, during the stalemate between Washington and Ankara (summer 2018), the Turkish lira recorded a drop of 19% against the dollar in one day.

In Forex, most currencies are quoted with the unit of the 4th decimal place. This fourth digit after the decimal point is called “pip” (percentage point). Defines the change in value between 2 currencies. The smallest movement is therefore equivalent to 0.0001, (4th digit after the decimal point). If the EUR / GBP pair moves from 0.8978 to 0.8979, the pair is said to have risen by one “pip”.

Good to know : the notable exception to this system is for pairs involving the Japanese yen. In this case, a pip corresponds to the movement of the second decimal place after the comma.

Forex profits are produced by the appreciation or depreciation of one currency against another. For example, if you buy dollars with euros, you will have to wait for the value of the single currency to increase relative to the greenback before reselling it, generating an exchange gain.

Les cambistes, les courtiers spécialisés qui interviennent sur le marché des changes pour le compte des investisseurs, se rémunèrent sur la différence (spread) entre les cours d’achats et de ventes qu’ils négocient pour chaque investisseur (par exemple une banque et une agency). With prices volatile, the promises of daily earnings are considerable.

Why invest in Forex?

You can invest in Forex in 2 ways:

  • The spot market allows the physical exchange of a currency pair in real time.
  • The futures market is that of future (derivatives) in which two parties enter into a purchase (or sale) contract whose price and quantity of currencies are defined in advance. The settlement date of the contract is set at the beginning.

To notice : legally a contract future it is more binding than a forward contract.

Most people who invest in Forex do so through a CFD (Contract for Differences). This contract (forward) allows you to exchange the price difference (spread) of a currency pair between the time the position is opened and the time it is closed. The principle of the CFD is simple: with a long position (buy) the investor makes a profit if the price of the pair rises and vice versa. With a short position (sell) the logic is reversed (gain if the value of the pair decreases). The use of CFDs has an advantage: it is possible to invest an amount greater than that of the initial deposit (hedging) thanks to the leverage effect: the position is opened by immobilizing only a small fraction of the total capital. This coverage is generally expressed as a percentage of the total position. Advantageous in the event of a win, this leverage is a double-edged sword. It is reversible. In case of failure to anticipate, the losses will be greater than the initial bet.

Before investing in the volatile foreign exchange market, you need to secure the services of a broker. The Financial Markets Authority (MFA) regularly warns investors against dishonest intermediaries domiciled outside France.

Furthermore, the MFA never misses an opportunity to remind you that Forex is reserved for informed investors.

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