what is forex

What is Forex and how does it work?-Ultimate Guide

What is Forex and how does it work: is it a suitable type of investment for any investor?

what is forex

Undoubtedly, the foreign exchange or Forex market is one of the most active on a global scale. Its daily trading volume is huge and the number of investors participating in it is really high compared to other markets.

However, is this a suitable investment for anyone?

In order to answer this question, I will begin by explaining to you in a simple way what Forex is and how this market works, as well as reviewing its most outstanding characteristics. Finally, I will give you my personal opinion about Forex and in which cases it is or is not convenient to use it.

✅ What is Forex?

Forex is simply the global foreign exchange market . Therefore, here the purchases and conversions of one currency against another materialize.

Thus, the acronym Forex stands for “Foreign Currencies Exchange” or “foreign currency exchange”. It is also known by the abbreviation FX.

It is a market that has a double face:

  • A practical component : as it allows you to invest in assets that are quoted in a currency other than your base currency.
  • A speculative side : in those cases where it is a question of taking advantage of the fluctuations in the conversion between currencies to obtain profits.

This speculative side is perhaps the best known and the one that makes Forex famous for being an extremely volatile, complex and unpredictable market . Thus, the price fluctuations are continuous and often sharp, so it is not a suitable type of operation for most investors.

Consequently, it is a complex market with a high level of risk.

Therefore, it requires adequate training, good money management and great control of the psychological aspect . In return, it can offer higher returns than other types of investments.

✅ How Forex works

Although, for reasons of space and technical complexity, we are not going to see in detail how Forex works in depth, I do want to explain some of its most outstanding features :

  • Global character : Forex is a global and decentralized market.
  • Continuous Operation – Operates 24 hours a day, five days a week (Monday through Friday). To be more precise, in practice, it is open from Sunday at 11 p.m. to Friday at 10 p.m.
  • Great liquidity : it is an extremely liquid market, in which the operations are closed immediately as soon as we give the order, thanks to the large number of investors that intervene at all times.
  • High trading volume – Forex has a high trading volume, with a daily average of about $6.6 trillion. In this way, you can exceed in a single day the trading volume that the New York Stock Exchange has throughout an entire week.
  • High volatility : the very nature of Forex causes prices to fluctuate continuously and, on many occasions, also abrupt.

In practice, trading on the Forex market is done through so-called currency or currency pairs. In the next section I explain what they consist of and how they are classified.

✅ What are Forex currency pairs and how are they formed

Indeed, currency pairs are the key to understanding Forex investing. In this way, all operations are based on the expression of the price of one currency against another, and are represented by the formula XXX/YYY , where:

  • XXX : are the initials of the so-called “base currency”.
  • YYY : represents the so-called “quote currency”.

For example, the EUR/USD pair will indicate the price of the euro expressed in dollars. Thus, if the price of this pair were 1.1447, this would mean that each euro is trading at 1.1447 US dollars.

Forex currency pairs are usually classified into four main groups:

  • Major Pairs – The major world currencies are located here, accounting for approximately 80% of the total Forex trading volume. Therefore, here are the aforementioned EUR/USD, USD/JPY (Japanese yen), GBP/USD (pounds) and USD/CHF (Swiss francs), among others.
  • Minor pairs : are those that may contain major currencies and other currencies, but do not include the US dollar. These pairs are traded less frequently than the previous ones, although they still tend to have a lot of volume. For example: EUR/GBP, GBP/JPY or EUR/CHF.
  • Exotic pairs: they are pairs formed by a currency belonging to the group of major currencies against another of smaller or emerging economies. For example: GBP/MXN (pound/Mexican peso), USD/PLN (dollar/Polish zloty), USD/HUF (dollar/Hungarian forint) or EUR/CZK (euro/Czech koruna).
  • Regional Pairs – This class simply refers to those currency pairs that are grouped together geographically. For example, in the Asia/Australia area, we have pairs like AUD/NZD (Australian dollar/New Zealand dollar) or AUS/SGD (Australian dollar/Singapore dollar).

As you can see, it is not difficult to understand the basics of the Forex market and how currency pairs work. However, knowing how to operate judiciously and with adequate risk management requires very specific training and progressive learning.

✅ How to invest in Forex: tools and strategies

Now that we have seen what Forex means and how it works, we can briefly discuss how to invest in this currency market.

To do this, we will start by seeing what options exist to start investing in Forex in practice. Later, I will explain the two main approaches or types of strategies that can be used to operate: fundamental analysis (focused on the macroeconomic) and technical analysis.

➡️ How to start investing in Forex: tools and basic operations

In practice, starting to invest in Forex does not require any specific tools nor is it complex from the point of view of basic operations. The difficulty really lies in knowing thoroughly:

  • How does this market work?
  • What strategy to apply at each moment.
  • How to manage risk properly.

Therefore, to begin with, you will have to open an account with a broker that offers Forex trading .

As I told you in my review of the best stock brokers , you should be especially careful when choosing these Forex brokers, since not all of them are 100% reliable or offer sufficient guarantees.

Once you have an account and have transferred funds to operate, you can start investing. To do this, there is a wide variety of products to operate with Forex that may vary depending on the broker you have chosen.

In this way, you can buy and sell currencies both spot and forward .

In addition, there are also many derivative products in the Forex market (such as futures, options, swaps , etc.).

Although, for reasons of space, I cannot explain what each of these derivative products consists of, keep in mind that they are investments with a high level of risk, not suitable for beginners.

Entering fully into the possible strategies or investment models in Forex , there are two main approaches, which can also be combined: fundamental and technical analysis:

➡️ The fundamental analysis – macroeconomic

This is a model that is generally considered more suitable for long-term investment in Forex .

In this way, it will take as a reference external factors that can directly influence currency prices, from geopolitical issues to macroeconomics, employment rates, etc.

From all this data and with the use of different tools, it is possible to try to obtain signals of behavior in the medium and long term of currencies. In short, trying to predict a price range for a currency at a specific time, with which it could be operated with a certain advantage against the market.

In any case, this type of strategy requires in-depth knowledge of macroeconomics and economic policy to be able to identify the factors that influence the price of each country’s currency.

For example, look at the evolution of the EUR/USD pair over the last few years:

As you can see, big movements are observed at times like the financial crisis of 2008.

The same thing happened in 2014, when the American economy was in full expansion, while Europe was still dragging the problems of the previous crisis, especially with the drag of the Greek economy.

➡️ Technical analysis in Forex

In Forex technical analysis, only factors directly related to the behavior and price of currencies are taken into account , instead of external factors. For example, the evolution of prices, trading volume, etc. will be analyzed.

There is no single technical analysis model.

In fact, two groups could be distinguished, although many elements of both approaches are intertwined in practice:

  • Statistical : It is based on the use of mathematical tools.
  • Graph : analyze the data from graphs, price curves, etc.

In this way, Forex technical analysis uses a large number of tools and indicators that, in some cases, are common to other technical analysis models.

For example: candlestick charts, oscillators, etc.

Unlike fundamental analysis, you can try to apply Forex technical analysis to virtually any trading window , even very short-term trades (eg, just a few minutes long).

In fact, many short-term Forex traders base their decisions solely on technical analysis.

✅ [Personal opinion] Is Forex an investment for anyone?

In my opinion, the Forex market, as a speculative investment , is not recommended for most people.

It is a very complex, volatile and risky investment model that requires adequate training and extensive knowledge not only of the foreign exchange market itself, but also of the tools that are going to be used when investing.

However, it is a market that, due to its great dynamism and the possibility of obtaining large returns in very short periods of time, is very attractive for beginners.

Unfortunately, in most cases, they end up losing all their money.

Therefore, take with great caution the advertisements of specialized Forex brokers that abound on the Internet, and even those that offer introductory courses of dubious quality.

On the contrary, the approach that seems most suitable for most investors is to go to Forex only to acquire currencies to invest in a country that uses a currency other than the euro or the one that is your base currency .

In this sense, I never use Forex for speculative investments , but only to be able to make investments in currencies such as the US dollar, the Canadian dollar or any other.

In short, although Forex may be attractive due to the promises of quick profits and the large advertising investment of certain brokers, it is not a suitable investment for most people .

Therefore, if you do not have a deep knowledge of the foreign exchange market, I advise you to only use it to access foreign currencies with which to make more conventional investments.

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