Forex, short for foreign exchange, is the largest financial market where different currencies are purchased and sold. It operates 24 hours a day, from Monday to Friday, since different parts of the world are in different time zones. People trade currencies for various reasons, such as travel, business or investing.
Understanding its evolution requires a journey through the history of money itself. The concept of money predates history, which has been recorded for thousands of years. Initially, various commodities served as mediums of exchange, ranging from precious metals like gold and silver to unconventional items such as animal hides and cowrie shells. However, the shift towards paper money occurred gradually, culminating in the widespread adoption of fiat currency, where the value is backed by the issuing government rather than a physical commodity. Today's foreign exchange markets directly result from this transition to paper money.
Each country issues its distinct currency, necessitating a mechanism for exchanging one currency for another. This exchange is fundamental for facilitating international trade, where transactions involve goods and services priced in different currencies. Consider a scenario where someone in India wishes to purchase goods from the United States. While rupees are used domestically, dollars are required for transactions across borders. Thus, individuals or entities must exchange their native currency for foreign currency, a process facilitated by the foreign exchange market.
How does Forex work?
Forex operates through a network of banks, dealers, and brokers, with the exchange rates constantly fluctuating based on the forces of supply and demand. When you exchange one currency for another, you are essentially selling one currency and buying another.
What determines the value of one currency versus another? The value of one currency compared to another is primarily determined by the basic principle of supply and demand. Those are essentially treated as commodities subject to the forces of supply and demand. Consider the relationship between India and the United States. If US companies outsource services to India, they need Indian rupees to pay for those services. Now, the relative demand for each currency determines its exchange rate. If there's a higher demand for US dollars compared to Indian rupees, the value of the rupee will depreciate against the dollar. A complex interplay of economic forces ultimately shapes the exchange rates observed in the foreign exchange market.
Factors influencing the Forex market
1. Economic factors: Economic factors such as GDP, inflation and interest rates have an impact on currency values.
2. Political factors: Political stability, geopolitical events and changes in government policies can affect currency prices.
3. Market sentiment: The overall sentiment and expectations of market participants can drive currency movements.
Key players of the Forex market
1. Commercial banks: Banks are the largest players here, facilitating transactions for clients and conducting speculative trades.
2. Central banks: Central banks play an important role in the Forex market. They set monetary policies and intervene to stabilise their country's currency.
3. Hedge funds and investment management firms: These entities trade currencies for speculative purposes and to hedge their portfolios.
4. Retail traders: Traders participate in the Forex market through online platforms and brokers.
5. MNCs: Companies engaged in international trade use Forex services to hedge against currency fluctuations and to facilitate cross-border transactions.
Types of Forex markets
1. Spot market: This is where currencies are purchased and sold at the current market price for immediate delivery.
2. Forward market: Here, parties agree to purchase or sell a specific amount of currency at a predetermined price, on a date in the future.
3. Futures market: It is just like the forward market, but the contracts are standardised and traded on an exchange.
Why Forex matters when traveling abroad
When traveling internationally, it's essential to carry the local currency of your destination. For example, if you're traveling from India to the United States, you'll need to convert your Indian rupees (INR) into US dollars (USD). The exchange rate determines how much foreign currency you’ll receive for your rupees. For instance, if the exchange rate is ₹80 to $1, it means you'll get 1 US dollar for every 80 rupees. So, converting ₹8,000 would give you $100. You can exchange currency through banks, travel agents, or foreign exchange services.
Conclusion
Forex, meaning the foreign exchange market, is a dynamic and complex environment where currencies are constantly traded. Understanding the key concepts, participants and factors influencing the market is essential for anyone looking to engage in Forex trading or to manage currency risk in international business.
The Axis Bank Forex Cards offer a convenient and secure method for managing foreign currency when travelling internationally. These cards are preloaded and can support up to 16 currencies with locked-in and discounted exchange rates. They offer exclusive offers such as 6 global ATM transaction fee waivers per year, as well as issuance, reload and encashment fee waivers along with insurance cover.
Also Read: What is a Forex Card and how does it work?
FAQs
How does Forex differ from other financial markets?
The Forex market is unique in its size, liquidity and 24-hour trading. Unlike stock and bond markets, there is no centralised exchange for Forex trading and transactions are conducted over-the-counter (OTC).
How do central banks affect the Forex market?
Central banks play a vital role in the Forex market. They set monetary policies, such as interest rates, and intervene in the market to stabilise their country's currency. They also manage foreign exchange reserves and regulate the banking system.
Does the Forex market function 24 hours a day?
The Forex market operates 24 hours a day, except on weekends. The market is divided into four main trading sessions: Sydney, Tokyo, London, and New York. The overlap between these sessions creates periods of high liquidity and volatility.
Disclaimer: This article is for information purpose only. The views expressed in this article are personal and do not necessarily constitute the views of Axis Bank Ltd. and its employees. Axis Bank Ltd. and/or the author shall not be responsible for any direct / indirect loss or liability incurred by the reader for taking any financial decisions based on the contents and information. Please consult your financial advisor before making any financial decision.
