Foreign Exchange is a deposit or payment in any national currency that is exchanged for a payment in another currency. Foreign exchange deals often take place between residents of different countries.
FOREIGN EXCHANGE MARKETS
The differentiating factor between capital and money markets and foreign exchange market is that foreign exchange market deals with the means of payment and not credit.
Foreign exchange effects only on the change of ownership of the money between different countries. It is a market where one currency is traded for another. However, the currencies and the extent of the participation of each currency in this market depend on local regulations of every market.
MARKET PARTICIPANTS
Market Participants can be differentiated based upon the risk and the amount of transaction they undertake.
At the first stage, there are customary users like tourists, importers, exporters who exchange domestic currencies for foreign currencies and traders and speculators who hunt for short-term profit.
At the second stage, Commercial banks act as a clearinghouse between users and earners of foreign exchange.
At the third level are the foreign exchange brokers who act as an intermediary between the banks and the market. Finally, the central bank acts as a buyer or seller at the time when the nation falls short of foreign exchange earnings.
EFFECTIVE FOREX TRADING
An effective forex trader will want to buy a currency at a lower price and sell it at a higher price to get optimum profit by minimizing the risk. An investor must first engage an efficient broker who can make sound investment decisions.
The major currencies that can be traded upon are EURO/USD, USD/JPY, etc. Any investor must collect up-to-date information about the global market. An investor must watch the trend of the prices of foreign currency daily to trade profitably.
The traders can enter forward exchange contracts to hedge against the risk of a change in the exchange rates. This contract can benefit the importers, and exporters by hedging a future import payment or export receipt.
PROFITABLE TRADING THROUGH BID-ASK SPREADS
A bid is a price at which a dealer buys another currency. An ask is a price at which a dealer sells the other currency. A spread is the difference between ask and bid prices. Narrow spreads are more profitable.
The spread can be wide when the exchange rates are abnormally volatile as they reduce the possibility of losses. The width of bid-ask spreads in forex transactions largely depends upon the transaction costs and risks.
Forex Trading can lead to high profits if we are thorough with the fundamentals of trading. Second, it involves the continuous gathering of knowledge related to the currency trend. Third, a wise trader must know the economic stability of the countries and the factors affecting it.