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Foreign exchange trading—also commonly called forex trading or FX—is the global market for exchanging foreign currencies. Forex is the largest market in the world, and the trades that happen in it affect everything from the price of clothing imported from trung quốc to the amount you pay for a margarita while vacationing in Mexico.
What Is Forex Trading?
At its simplest, forex trading is similar to the currency exchange you may vì while traveling abroad: A trader buys one currency and sells another, and the exchange rate constantly fluctuates based on supply và demand.
Currencies are traded in the foreign exchange market, a global marketplace that’s open 24 hours a day Monday through Friday. All forex trading is conducted over the counter (OTC), meaning there’s no physical exchange (as there is for stocks) & a global network of banks và other financial institutions oversee the market (instead of a central exchange, lượt thích the thủ đô new york Stock Exchange).
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A vast majority of trade activity in the forex market occurs between institutional traders, such as people who work for banks, fund managers và multinational corporations. These traders don’t necessarily intend to lớn take physical possession of the currencies themselves; they may simply be speculating about or hedging against future exchange rate fluctuations.
A forex trader might buy U.S. Dollars (and sell euros), for example, if she believes the dollar will strengthen in value & therefore be able to buy more euros in the future. Meanwhile, an American company with European operations could use the forex market as a hedge in the event the euro weakens, meaning the value of their income earned there falls.
How Currencies Are Traded
All currencies are assigned a three-letter code much lượt thích a stock’s ticker symbol. While there are more than 170 currencies worldwide, the U.S. Dollar is involved in a vast majority of forex trading, so it’s especially helpful to know its code: USD. The second most popular currency in the forex market is the euro, the currency accepted in 19 countries in the European Union (code: EUR).
Other major currencies, in order of popularity, are: the Japanese yen (JPY), the British pound (GBP), the Australian dollar (AUD), the Canadian dollar (CAD), the Swiss franc (CHF) and the New Zealand dollar (NZD).
All forex trading is expressed as a combination of the two currencies being exchanged. The following seven currency pairs—what are known as the majors—account for about 75% of trading in the forex market:
How Forex Trades Are Quoted
Each currency pair represents the current exchange rate for the two currencies. Here’s how khổng lồ interpret that information, using EUR/USD—or the euro-to-dollar exchange rate—as an example:The currency on the left (the euro) is the base currency.The currency on the right (the U.S. Dollar) is the quote currency.The exchange rate represents how much of the quote currency is needed lớn buy 1 unit of the base currency. As a result, the base currency is always expressed as 1 unit while the quote currency varies based on the current market và how much is needed to buy 1 unit of the base currency.If the EUR/USD exchange rate is 1.2, that means €1 will buy $1.20 (or, put another way, it will cost $1.20 to buy €1).When the exchange rate rises, that means the base currency has risen in value relative to lớn the quote currency (because €1 will buy more U.S. Dollars) and conversely, if the exchange rate falls, that means the base currency has fallen in value.
A quick note: Currency pairs are usually presented with the base currency first & the quote currency second, though there’s historical convention for how some currency pairs are expressed. For example, USD to EUR conversions are listed as EUR/USD, but not USD/EUR.
Three Ways to Trade Forex
Most forex trades aren’t made for the purpose of exchanging currencies (as you might at a currency exchange while traveling) but rather khổng lồ speculate about future price movements, much like you would with stock trading. Similar to lớn stock traders, forex traders are attempting khổng lồ buy currencies whose values they think will increase relative to lớn other currencies or to get rid of currencies whose purchasing power nguồn they anticipate will decrease.
There are three different ways lớn trade forex, which will accommodate traders with varying goals:The spot market. This is the primary forex market where those currency pairs are swapped and exchange rates are determined in real-time, based on supply & demand.The forward market. Instead of executing a trade now, forex traders can also enter into a binding (private) contract with another trader và lock in an exchange rate for an agreed upon amount of currency on a future date.The futures market. Similarly, traders can opt for a standardized contract to lớn buy or sell a predetermined amount of a currency at a specific exchange rate at a date in the future. This is done on an exchange rather than privately, like the forwards market.
The forward và futures markets are primarily used by forex traders who want to lớn speculate or hedge against future price changes in a currency. The exchange rates in these markets are based on what’s happening in the spot market, which is the largest of the forex markets và is where a majority of forex trades are executed.
Forex Terms lớn Know
Each market has its own language. These are words to know before engaging in forex trading:Currency pair. All forex trades involve a currency pair. In addition lớn the majors, there also are less common trades (like exotics, which are currencies of developing countries).Pip. Short for percentage in points, a pip refers to the smallest possible price change within a currency pair. Because forex prices are quoted out to at least four decimal places, a pip is equal lớn 0.0001.Bid-ask spread. As with other assets (like stocks), exchange rates are determined by the maximum amount that buyers are willing to pay for a currency (the bid) and the minimum amount that sellers require to lớn sell (the ask). The difference between these two amounts, and the value trades ultimately will get executed at, is the bid-ask spread.Lot. Forex is traded by what’s known as a lot, or a standardized unit of currency. The typical lot form size is 100,000 units of currency, though there are micro (1,000) and mini (10,000) lots available for trading, too.
What Moves the Forex Market
Like any other market, currency prices are mix by the supply và demand of sellers và buyers. However, there are other macro forces at play in this market. Demand for particular currencies can also be influenced by interest rates, central bank policy, the pace of economic growth & the political environment in the country in question.
The forex market is xuất hiện 24 hours a day, five days a week, which gives traders in this market the opportunity to react to news that might not affect the stock market until much later. Because so much of currency trading focuses on speculation or hedging, it’s important for traders to lớn be up lớn speed on the dynamics that could cause sharp spikes in currencies.
Risks of Forex Trading
Because forex trading requires leverage and traders use margin, there are additional risks lớn forex trading than other types of assets. Currency prices are constantly fluctuating, but at very small amounts, which means traders need to execute large trades (using leverage) lớn make money.
This leverage is great if a trader makes a winning bet because it can magnify profits. However, it can also magnify losses, even exceeding the initial amount borrowed. In addition, if a currency falls too much in value, leverage users mở cửa themselves up lớn margin calls, which may force them khổng lồ sell their securities purchased with borrowed funds at a loss. Outside of possible losses, transaction costs can also showroom up và possibly eat into what was a profitable trade.
On vị trí cao nhất of all that, you should keep in mind that those who trade foreign currencies are little fish swimming in a pond of skilled, professional traders—and the Securities và Exchange Commission warns about potential fraud or information that could be confusing khổng lồ new traders.
Perhaps it’s a good thing then that forex trading isn’t so common among individual investors. In fact, retail trading (a.k.a. Trading by non-professionals) accounts for just 5.5% of the entire global market, figures from DailyForex show, và some of the major online brokers don’t even offer forex trading.
What’s more, of the few retailer traders who engage in forex trading, most struggle khổng lồ turn a profit with forex. CompareForexBrokers found that, on average, 71% of retail FX traders lost money. This makes forex trading a strategy often best left lớn the professionals.
Why Forex Trading Matters for Average Consumers
While the average investor probably shouldn’t dabble in the forex market, what happens there does affect all of us. The real-time activity in the spot market will impact the amount we pay for exports along with how much it costs khổng lồ travel abroad.
If the value of the U.S. Dollar strengthens relative khổng lồ the euro, for example, it will be cheaper khổng lồ travel abroad (your U.S. Dollars can buy more euros) & buy imported goods (from cars lớn clothes). On the flip side, when the dollar weakens, it will be more expensive to lớn travel abroad & import goods (but companies that export goods abroad will benefit).
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If you’re planning lớn make a big purchase of an imported item, or you’re planning lớn travel outside the U.S., it’s good khổng lồ keep an eye on the exchange rates that are phối by the forex market.