In this article, we will give you a basic understanding of forex trading and tell you about the complexities involved, which make it so exhilarating.
What is forex?
Forex stands for Foreign Exchange. It is a global and decentralized market for trading currencies. It is controlled by the value of the currencies of various countries. These currencies, themselves, rely on a combination of Governmental Activities and the market forces of demand and supply for their valuation.
How does Forex trading work?
Forex trading is a complicated process, but the concepts it functions on are pretty easy to understand.
Currencies have different values which are recognized by countries globally. And because their values are acknowledged, these currencies can be exchanged for each other in a very similar way to how you exchange money for commodities.
Let’s use a simple example to under how this exchange works.
Suppose you’re a Canadian visiting India and want to make purchases on your trip. In that case, you first need to exchange your currency, the Canadian Dollar, for the destination country’s currency, the Indian Rupee. At that point, you will be given a certain rate of exchange, let’s say, C$1 = ₹60 rupees. So, you exchange your C$1 for ₹60.
After you’re done with your vacation a month later, you go back to the exchange counter to exchange your remaining INR notes. But this time, you’re provided with an exchange rate of C$1 = ₹30. This means that you get C$2 in exchange for your ₹60. This is a profit of C$1.
This profit is the basic goal of forex trading.
You exchange your currency for another currency when it’s valued lower, and when the value increases, you exchange it again and make a profit.
Then why is Forex trading so Complicated?
Though this kind of trading’s basic idea is quite easy to understand, the thrill comes from practice. The basic motive of any trading is to make a profit and make that profit, and you need to consider a lot of factors.
Since this exchange depends, to a large degree, on economic forces, understanding the economies of both the countries concerned with the particular exchange becomes very important. This is a very complex and complicated process since economies are very volatile and are affected by a huge number of factors.
Though it’s practically impossible to make an exhaustive list of these factors, a few major ones are listed below, do note that these apply to both the countries involved in the exchange.
- Administrative Conditions – This includes the Government’s ideologies and principles about business and the country’s general functioning, along with the overall efficiency of administration.
- Economic Conditions – You need to track the countries’ economic growth if there are any risks to the economies or any other major changes that can be forecasted from research.
- Conditions of Trading Partners – This includes the trading relations between countries. If one country is going through an economic depression, the effect will be felt by all its trading partners.
- Conditions of Trading Rivals – This includes the health and relations of major trading rivals a country has and what kind of policies are being implemented to react to these rivalries.
- Military and Diplomatic Relations – These factors also play a major role, as good relations are mostly built based on diplomatic and good military relations. If two countries have tensions relating to these factors, their economic relations will be affected in a major way.
So, we’ve shown you how forex works and what complexities make it such an interesting activity. And we hope that you are now interested enough to delve deeper into the field.