Forex Trading – What Exactly Is It?

Forex Trading – What Exactly Is It?

The forex market is the global interbank market where all currencies are traded. It’s just like any other market with real people buying and selling, only that there is no need for face to face exchange or need to move to the market place as everything is done online through platforms provided by brokers. It may sound complex, and indeed it is, yet we at Forex School Uganda will make it extremely easy for anyone interested in trading the financial markets through extremely teaching that anyone hearing about Forex trading for the first time will be able to trade it. Of course its not immediately, but our proprietary teaching methods and markets approach when learnt and applied will discipline will turn any newbie into a professional in record time.


The forex market is the largest of all financial markets. Its worth about to 3times bigger than the global GDP, with about $6 trillion traded every trading day in spot transactions.


What is FOREX?



The word FOREX a short form for Foreign Exchange. Forex as a trade or forex trading is the exchanging of one currency for another. Think of it in terms of you visiting a new country. You came in with your home currency which is not legal tender in the country you’re visiting. For you to be able to transact you would need to have currency or you’ll starve. So you go to a bank or a forex bureau and exchange your country’s currency for the new ones. Your home currency was FOREIGN and you EXCHANGED it for that of the country visited. That’s the premise for Foreign Exchange or FOREX. The participation in this kind of exchange as a trade for profit is what is known as ‘FOREX TRADING’.


Each Forex trade can theoretically be viewed as a ‘spread’ trade where to buy one currency you must sell another. These currencies are traded in pairs, one against the other. Convention dictates that currencies are measured in units per base currency, the base being the first currency in the pair. For example, USDCHF. USD is the base currency and CHF is the quote currency in the pair. So any buying or selling of the pair will be the buying or selling of the USD against the CHF. And like we said, these currencies will be measured in units per 1USD. For example, 1 USD is as of today worth 0.94000 CHF. As a result, when USD/CHF appreciates in value, it is the USD that has appreciated in value relative to the CHF and not vice-versa. Position-wise, to own or to be ‘Long’ on USDCHF means that you are long on the USD and concurrently short on the CHF. In very simple terms, when you place a ‘buy’ position on the USDCHF pair, you have bought the USD and concurrently or by default sold the CHF. So the USD in the USDCHF pair is the default ‘lead’ currency.


About Foreign Exchange Market

The Foreign Exchange market, also referred to as the “Forex” or “FX” market, is the largest financial market in the world, with a daily average turnover of well over US$1 trillion — 30 times larger than the combined volume of all U.S. equity markets. Forex trading is the simultaneous buying of one currency and selling of another. There are two reasons to buy and sell currencies. About 5% of daily turnover is from companies and governments that buy or sell products and services in a foreign country or must convert profits made in foreign currencies into their domestic currency. The other 95% is trading for profit, or speculation. These currencies are mainly known as ‘Majors’ by the simple fact that the ‘Majority’ of transactions on the forex market are mainly about them.

The major pairs are the four most heavily traded currency pairs in the forex market. Owing to their volume of transactions on the market they are the most liquid. The four major pairs at present are the EUR/USD, USD/JPY, GBP/USD AND USD/CHF.   These major currency pairs are deliverable currencies and are part of the G10 economies currency group. For speculators, the best trading opportunities are with these majors. And as such, trade volume of these currency pairs is related to both economic transactions as well as heavy speculation.

The major pairs are considered by many to drive the global forex market and are the most heavily traded. Although it is widely regarded that the major pairs consist of only four pairs, in reality USDCAD, AUDUSD, and NZDUSD pairs should also be regarded as majors. These three pairs are part of the “commodity pairs” group.

More than 85% of all daily transactions involve trading these seven currency pairs with the EUR/USD being the world’s most heavily traded currency pair, representing more than 20% of all forex transactions.


The forex market never ‘sleeps’. It’s a 24-hour open market. Forex trading begins each day in Sydney, and moves around the globe as the business day begins in each financial center, first to Tokyo, London, and New York. Unlike any other financial market, investors can respond to currency fluctuations caused by economic, social and political events at the time they occur – day or night. The forex market is considered an Over The Counter (OTC) or ‘interbank’ market, due to the fact that transactions are conducted between two traders around the world over the telephone or via an electronic network. Forex trading is not centralized on an exchange, as with the stock and futures markets. The foreign exchange market is not a “market” in the traditional sense.


Types of Market Participants in Forex Market



The forex market being the largest financial market attracts all sorts of player seeing to get a piece of its cake. As such there a number of market participants including corporations and individuals. The skilled professionals and the gambling amateurs are all part of the market. The main Participants Forex Dealers who are mainly bank traders and are among the biggest participants, Brokers, Hedgers, Speculators, Arbitrageurs, Central Banks, and Retail Market Participants.


Commercial Banks

These are also known as forex dealers and interact with each other on the interbank market. The interbank market caters for both the majority of commercial turnover as well as enormous amounts of speculative trading every day. Their trading volumes usually numbers in the billions daily. These dealers participate in the Forex markets by providing bid-ask quotes for currency pairs at all times. Some of this trading activity is undertaken on behalf of customers, but a large amount of trading is also conducted by proprietary desks, where dealers are trading to make the bank profits. As dealers, banks profit from the bid or ask spreads they implement on exchange rates quoted to their clients. As many as 100 to 200 banks worldwide makeup the market in the foreign exchange.


Interbank Brokers

Until recently, the foreign exchange brokers were doing large amounts of business, facilitating interbank trading and matching anonymous counterparts for comparatively small fees. Today, however, a lot of this business is moving onto more efficient electronic systems that are functioning as a closed circuit for banks only. Still, the broker box providing the opportunity to listen in on the ongoing interbank trading is seen in most trading rooms, but turnover is noticeably smaller than just a year or two ago.


Foreign Exchange Brokers

Brokers exist because they add value to their clients by helping them obtain the best quote. They allow private individuals to access the forex market by transmitting their clients’ orders to commercial banks or to trading platforms such as EBS, Reuters Dealing, HotSpot, FXall, among other. A trader wouldn’t need a broker if they could call the dealer directly and obtain a good rate but it needs the technical knowhow to do so. And as such, brokers come in handy. They keep track of the changing exchange rates available on the interbank market using sophisticated systems to help their clients obtain the lowest buying price or the highest selling price by making available quotes from several dealers. These broker companies’ main objective is to bring together buyers and sellers of foreign currency. Some brokers get paid by charging commission on each transaction but most don’t and usually get their fee from the spread. Also, there are many brokers that operate as market makers; like commercial banks, they also provide their clients with a buy/sell (bid/ask) price to earn the spread if they are able to find a buyer and seller at the same time.


There are mainly two types of brokers:


Market Maker (Dealing Desk Broker)

This kind of broker is the counterpart of every transaction made by the trader. When a trader opens a transaction the broker opens a similar position but against the trader. If for example the trader shorts one currency pair, the broker will long the same currency pair with the same position size. This is kind of hedge trading where a clients position is hedged against by a counterpart position by the Money Maker betting on the  clients position to lose. These kind of brokers know that most of the traders on the markets fail and they seek to take advantage of the failure rate. As a trader, such brokers are dangerous to deal with since they don’t have the clients’ best interests. By hedging against your positions, they are essentially trading against you. This blatant conflict of interest means they’re unlikely to avail you accurate price feeds. They are likely to manipulate it to ensure the clients’ position losses, as such losses are their gains.


Non Dealing Desk (ECN Broker)

The broker only connects the trader to banks through an ECN (Electronic Communication Network). They do not trade themselves. Unlike the banks, brokers serve merely as matchmakers and do not put their own money at risk. As such, to get paid for their service, they usually charge a commission plus the spread, but their fees can at times be smaller than what Market Makers charge just for the spread.


Investors and Speculators

Speculators are a class of traders that are in the market to buy and sell currencies just for profit. They purchase financial instruments with the expectation that it will become more valuable or profitable in the near future. They have no need for the foreign currency. They buy when they determine the price to be low with the hope that its value will increase so they can sell it at a higher value for a profit. Their transactions are purely speculative as no one can tell for sure whether the market will go up or down. As in all other efficient markets, the speculator performs an important role taking over the risks that commercial participants do not wish to be exposed to. Decisions of speculative investors are based on technical analysis rather than fundamental analysis of forex trading. They are more active traders than the “buy and hold” investors. Their positions are transient and seek profits from a short-term price change.


Commercial Companies

These companies deal with banks much like hedge funds. Many giant corporations often deal with the larger banks directly. They trade in goods and services and if payments are not in their local currency, payment in  US dollars is a preference. To be able to have these transactions done, these companies need foreign currency which they acquire through banks. That’s how by default they get to participate in the foreign exchange markets. For example, when one company in one country wants to buy or sell to another company in a different country, the currencies of the countries of these two companies are only legal tender locally and can’t be used in the transaction. Off course this is only different if the purchasing company pays its seller in the seller’s country’s local currency. Unfortunately, this is not usually possible and so preference is with internationally recognized mediums of exchange like US dollars, Euros, GB pounds. So to complete this transaction a foreign exchange transaction is likely to occur.

Companies also sometimes participate in the Foreign exchange markets to hedge their exposure. They have to buy or sell currencies as a hedge against future exchange rate movement. For example, there are times when one company is to be paid in the future in its home currency but the home currency’s value has been depreciating and the downward trajectory is expected to continue through the time the payment comes. This would mean loss to the company through the currency depreciation as one currency note worth ten dollars today may be worth five dollars tomorrow through the currency loss of value. To counter this, they need to hedge against the depreciation. And so by locking into today’s exchange rates, companies can take exchange rate risk out of the equation. The company can sell its home currency and buy the other currency in the same amount of the payment to be received. This way the price fluctuation will not affect the company.


Central Banks

Central banks play a pivotal role in the foreign exchange markets.  They are the primary issuers of currency in any country and control its supply within the economy. Their role is to regulates the exchange rates of the currency of their respective country to ensure fluctuations within the desired limit and keep control over the money supply in the market. As such, they formulate policies by which they frequently intervene in the market to maintain the exchange rates of their currency within a desired range and to smoothen fluctuations within that range. These interventions are done to stabilize or increase the competitiveness of that nation’s economy through the depreciation or appreciation of their currency’s value. During deflationary periods, central banks tend to weaken their currencies by creating additional supply which is then used to buy foreign currency. As a result, their own currency is weakened increasing the competitiveness of the economy’s exports globally. We can see that their participation is not for any speculative purposes but simply to control the supply of money within the economy to enable an economy achieve its economic goals.  Their actions help ensure price stability of exchange rates, protect price levels within the exchange rate, steer growth and cub inflation by protecting the disequilibrium in the prices of foreign exchange. Forex traders use central banks’ actions as long-term indicators.


Hedge Funds

Hedge funds are private pooled investment vehicles. Capital from individuals or institutions in form of partnerships is pooled and invested in different asset classes including currencies with the aim of huge returns for the investors by the fund manager otherwise known as the general partner. After the central banks, these are likely the second biggest participants in the forex market. The once ‘secretive’ and ‘investor-avoided’ investment vehicle is today a run-to option for the same investors despite the associated risks. The Hedge fund industry is so big with a value of more than $3 trillion, making up a significant part of the forex market.


They are known to make big money. There’s a wide arsenal of trading strategies employed by these funds to make the best of the price differences between different currencies and to take advantage of inefficiencies in the market. Of course the strategies differ from one fund to the other. For example, some will prefer situations where they have to buy and sell the same asset in different markets in order to profit from the price differentials on the same asset in the different markets while the others don’t. This arbitrage strategy is complicated and some prefer investing in specific situations as opposed to arbitrage ones. Hedge funds heavily engage in speculative trading.

Fund managers are active foreign exchange traders. They access the foreign exchange market to acquire foreign currencies required to fund cross-border investments.

These funds employ traders who actively speculate in the forex market and act as clients of large market makers. Also, fund managers may have to convert one currency into another to be able to pay for assets they wish to buy for the fund, e.g. stocks or other financial instruments. The forex exchange speculation carried out by hedge funds has gained a reputation for aggressive currency speculation in recent years. Some hedge funds execute trades automatically on an algorithmic basis.


Individual Traders

These are retail traders like you and me. Individuals and small businesses also use the foreign exchange market to facilitate execution of commercial or investment transactions. Other individual participants are tourists who visit from different countries. These tourists have a need for foreign exchange. Remember they are not locals, they just came in from elsewhere. That means they came in with their home country’s currency. As such, they would need to exchange it for the local currency for them to be able to transact on the local market. Such people play a tiny part in the forex trading business. The forex needs of these players are usually small and account for only a fraction of all foreign exchange transactions. Even then they are very important participants in the market.


There are however individuals who don’t deal with foreign exchange houses such as bureaus or banks, as they have no need for the physical exchange. Their forex transactions are carried out online. These are not mere currency exchangers but traders. They buy and sell currencies not because they need it but for speculative reasons. Retail forex trading is a small part of the market where investors aim to profit from exchange rates between different currencies. They carry out trading through a broker using a broker’s platform.


A retail trader will choose a broker, open up an account and make a deposit. After that, the trader can simply start making trades. The most common trading platform for such is the metatrader4 or the MT4. These traders use different strategies based on both technical and the fundamental aspects of the market. They analyze the markets based of chart patterns and keep track of macroeconomic news events. They use different trading styles to suit their trading needs and goals. They trade as an occupation, a business. They’re in it for profit. As such, there’re risks involved including the loss of some or all their investment. Proper professional education and training is necessary if they are to trade successfully and stay in the business for the long haul.


In our mentorship program at Forex School Uganda, we offer such specialized education and professional training to enable anyone without prior knowledge of the forex markets to trade successfully


Godfrey Kakulu

Your Forex Trading Coach and Mentor

Professional Training and Education in Forex, Cryptocurrencies, Indexes, Commodities and Precious metals

Godfrey Kakulu

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