Understanding Forex Trading Systems

Understanding Forex Trading Systems

Currency exchange has been an important part of every transaction made between countries. Currency plays a  big role in buying and selling products. A Canadian consumer will not be able to buy goods in Australia, unless his money with a Canadian dollar currency will be converted to Australian dollar. An American who wants to travel to Japan has to convert his American dollars to yen so that he can manage his expenses in Japan. A Chinese businessman has to convert his yuan to dollars so he can buy his raw materials abroad.

Frequent transaction among different countries only proves the importance of currency exchange. Because of this, forex trading was developed. There are some people who are knowledgeable in forex trading. In fact, if one is knowledgeable in it and plays this really well, he can earn almost 50% of his investment. Because of the high profits, forex trading is also very risky. That is why understanding forex trading systems is very crucial, especially to those who do not have any knowledge of it but are willing to take its risks.

Forex trading is a shortened term for foreign exchange trading. It is also termed as FX or currency market. Forex is like the other types of trading that it includes buying and selling, but in forex, currencies are traded.

Forex is described as one of the most liquid financial market in the world. The traded value in the stock market per day is $2000 billion in US dollars, but in August 2012, according to the Bank of International Settlements, the forex market already has a traded value of more than U.S. 4.9 trillion per day.

One of the forex trading advantages is its accessibility. The trading is open for 24 hours per day. Forex has no central marketplace. Trading is done online bilaterally between different traders around the globe. The reason for its accessibility is that its financial centers are located in different parts of the world. The major financial centers are in Tokyo, Zurich, Hongkong, Singapore, New York, London, Paris, and Sydney.

There are three ways to trade in forex. The first method is the spot market. People usually refer to spot market when they refer to the forex market. In spot market, the currencies being traded are based on the current price. The price is determined through the market supply and demand. The transaction is made between two parties that agrees and receives the agreed-upon currency. A finalized deal is called a spot deal. Transactions in spot market are done presently.

The second method is forwards market. There are contracts involved in forwards market. Unlike in spot market, transaction in forwards market is made through contracts that represent currencies with price per unit along with the future date for settlement. 

The third method is a futures market. Just like forwards market, futures market doesn’t trade currencies. Future contracts are traded in this market. These contracts are based on the size and the future settlement date on public commodities market. The contract includes price per unit, future delivery and settlement dates, and minimum price increments that are fixed.

For further understanding of forex trading systems, history plays a big part on how the currency market has evolved. Long time ago, people commonly used gold and silver for trading. This method was not very ideal because its value could depreciate any time depending on its supply and demand.

In 1875, the gold standard monetary system was created.  In this system, the value of a  country’s currency of paper money was linked to gold. Paper money could be converted to gold.  In 1931, Britain stopped using the gold standard. The United States also stopped using the gold standard monetary system in 1971.

One reason why it had become ineffective was because of the financial burden it caused to Europeans during the beginning of the World War I. Gold reserves were not enough to exchange for printed currencies.

In July 1944, representatives from allied nations  had a meeting at Bretton Woods, New Hampshire. They agreed to set up a monetary system that solved some of the cons of the gold standard monetary system. This monetary system is called the Bretton Wood System. Using this system, the U.S. dollar became the based currency that replaced the gold from the gold standard monetary system. The U.S. dollar was the only currency that could be exchanged for gold. A fixed exchange rate was introduced as well. The International Bank of Reconstruction, International Monetary Fund and Development and the General Agreement on Tariffs and Trade were created to monitor economic activities.

Due to the lack of gold reserves, the U.S. eventually failed to trade gold for U.S. dollars. Because of this, the Bretton Woods Monetary System died.

After the Bretton Woods Monetary System, The world accepted the use of the floating foreign exchange rates. This had emerged after an agreement was made in 1976 in Jamaica. In this monetary system, the use of gold in the currency market was demolished. Most governments of different countries use one of the three exchange rate systems and these are: dollarization, pegged rate, and manage-floating rate. 

Understanding the primary jargons used in forex is very important for understanding forex trading systems. Knowing how to read quotes is the initial step to understand forex.

A quoted currency refers to the relationship two currencies. The U.S. dollar currency is the one that is commonly traded with the other currency. A forex quote has two parts: the base currency and the counter currency. If the U.S. currency is used as the base currency, the quote currency is direct. If the U.S currency is used as the counter currency, the quote currency is indirect. An example of a direct quote is 120 JPY/USD, which means that 1 USD= 120 JPY. An example of an indirect quote is 0.01USD/JPY, which means that 1JPY= 0.01 USD. Cross currency refers to as the use of another currency instead of the USD as the base currency or as the counter currency (93 JPY/CAD).

The ask price refers to the amount of quoted currency that is needed to buy the base currency. The bid price refers to the amount of quoted currency that will be obtained when a base currency is sold. The bid price is always smaller than the ask price. The difference between the ask price and the bid price is called spreads. The pips or the points refer to the smallest amount of price movement in currency quote.  In a currency quote such as  EUR/USD=1. 2500/03, the base currency is EUR, the counter currency is USD, the bid price is 1.2500, the ask price is 1.2503, the spread is 0.0003 and the pips is 0.0001.

To profit from forex trading, it is very important to be very knowledgeable in it. It is advisable to consult an experienced forex trader before engaging in forex trading because, forex is very risky. However, in financial investments like this, a higher risk means a higher profit.