How the Forex Market Work? This is really quite a complex question to answer and there’s more than one answer in truth. In the Forex market, all the main banks quote their prices for the foreign currency. Just like any other market, each bank may quote a different price from another bank. A broker takes all these quoted prices and makes an average. The prices you see from your broker are usually an approximate average of all the prices cited by major banks across the world. It is impressive, isn’t?
So, the work of a broker is to transact the trade. By taking the other side, they make the market for you, the buyer. When you go to buy a particular currency, it is the broker selling and not any other trader. How the Forex market work… to understand fully, we need to go back and look a little into history. It will soon become much clearer.
How the Forex Market Work – Forex History
To fully appreciate the role of the Forex market, we should look at a brief history of the market. I admit this might a little bit boring, but we would not do it if it were not important. Furthermore, some few historical facts of the market will tell you why the market exists in the first place and how it got here. So stay with me.
It all began in 1876 with the implementation of something called the gold standard. The gold standard was a standardization framework for paper currencies. All paper currencies had to be backed up by pure solid gold. Sounds dumb, right?
It was a very brilliant idea to stabilize world currencies through pegging them to the price of gold. Theoretically, it was perfect, but in practice, not so good. It created boom-bust patterns that led to the demise of the idea of gold as a standard. Around the beginning of World War 2, the gold standard was dropped. Most European countries did not have enough gold to support all the currency printed to pay for the large military projects during the war.
Despite the fact that the precious metal was dropped as a standard, it never lost its value as the ultimate form of monetary value. The world had to come up with a new fixed exchange rate. It is then that the U.S dollar was made the primary reserve currency and it would be the only currency backed by gold. The system was called the Bretton Woods System. Did I mention this was around 1941?
The Bretton Woods System, however, was not to live for long. In 1971, the United States (Richard Nixon particularly) decided that it would no longer exchange gold for U.S dollars held in foreign reserves. The death of the Bretton Woods System led to the acceptance of floating foreign exchanges in many countries across the globe. This was in 1976 and is year the current foreign currency exchange market was born. Wide electronic trading began much later, in mid 1990s.
So what is Forex trading?
Forex trading is what concerns you and I as retail traders. It is the speculation on the price of one currency against another. Quite a mouthful, but here is an example. If for any particular reason you think the euro will rise against the U.S dollar, you will buy the EURUSD currency pair at a low price. Hopefully, you sell it at a higher price and make tons of profit.
Otherwise, if you purchase the EURUSD and the euro does not rise against the dollar as you had hoped, you will sell it a lower price making enormous losses. The rewards are great, but so are the losses. Therefore, a smart forex trader should be aware of the risks involved in Forex trading.
How the Forex Market Work – Why is the Forex market so popular?
Foreign exchange currency trading is a dream come true for everyone smart enough to get there. It offers incredible potential lifestyle of any profession in the world. Of course, it’s hard to get there, but as promised I will show you how to. First and foremost, you have to be determined and disciplined. If you are both determined and disciplined, then you are more than half way there to success.
Here is a quick list of other attributes that you need to reach your goals in the Forex market… and let me warn you first, it’s easier said than done.
- Ability to lose without becoming emotional or giving up – the Forex market is full of losses, it is not for those who give up after the first trial.
- Confidence – you need to have faith in yourself. Make your trading strategy; believe in it and run with it, without fear.
- Dedication – Forex trading is not for the faint hearted. Do whatever you have to do to become the best trader (legal stuff only, please).
- Flexibility – the Forex market changes more often than the weather. You need to be flexible enough to adjust to the changing market conditions.
- Discipline – remain calm and unemotional in good and in bad times. And trust me, you will have your moments.
- Focus – the market is tempting. Sometimes, it sends mixed signals, other times your friends will sway you.
Be focused enough to make your decision and stick to it (rain or sunshine).
- Logic – a good trader should analyze the market subjectively, not how they would like it to work.
- Organization – as a trader, have trading principles and reinforce them.
- Patience – plan and stay watch. When the highest probability of success hits, strike and strike hard. Only patience will get you there.
- Be Realistic – don’t be overambitious or greedy; it is not a lottery. You certainly will not become rich tomorrow.
- Be Street Smart and Savvy – stay ahead of the game, always know what is happening in the market. Technology would be a great friend here.
- Self-control – Be ambitious but not stupid, do not over leverage your trading account.
The high leverage and volatility of the Forex market is a gold-mine if you know how to use it. Take full advantage of this to learn and master effective Forex trading strategy. Around the strategy, build an effective trading plan. Most importantly, follow your plan with military style discipline. Leverage is a double-edged sword; it can make you all the riches you have ever dreamt of or make you poorer than you have ever imagined.
The one point that I should bold, italicize and put in uppercase for emphasis is money management. Money management is what makes or breaks a Forex trader. Unfortunately or fortunately, depending on how you look at it, there is only one rule to money management. Here it goes: always know the exact amount of dollars you are totally ok with losing before entering into any trade.You are not special, no one is and any trader could lose.
So before trading remember to ask yourself, “if I lose, what’s at stake”?
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