What is forex market?

what is forex market

What is forex market? Well..it’s a marketplace no different than other marketplaces. Instead of selling and buying goods you sell and buy currencies. Currencies are also considered as goods, the most requested goods in the world.

Giving you the exact definition of forex market won’t help very much in understanding how it works. For the sake of simplicity, let’s suppose that the market consists of just 2 persons: me and you. Please bear in mind that this is just an example, the real market consists of banks, financial institutions, hedge funds and individual traders. But for now, let’s consider our little forex market, just you and me. If you understand how the system works for 2 players, it will be easy to extrapolate to many players.

Suppose I got 10 USD and 12 EUR in my pocket and you have the same. For 1 EUR, I must pay 1.2 USD (it’s just an example, not the actual exchange rate). This means that EURUSD current level is 1.2

I’m in Europe right now and I need to go to US for a trip. EUR is useless there, so I need more USD. So, I want to buy more USD from you. But you, as a greedy marketer, want to speculate my need of USD. And when I come to you to buy USD, you smile at me, and say:

– No, I won’t sell my USD to you, I won’t give you my 10 USD for 8.3 EUR. You desperately need USD so how about selling you my 10 USD for your 10 EUR?

Hmm, if I go to a bank I could buy 10 USD for 8.3 EUR, 1.2 USD/EUR. But I don’t have time to go to a bank right now, I will miss the plane. Ok, so be it, where I’m going right now I don’t need EUR anyway.
EURUSD just dropped to 1 from 1.2 as it previously was.

After the deal, I have 20 USD and 2 EUR in my pocket and you have 14 EUR and no USD left.

When I return from USA, I will need EUR again so I have to buy EUR at existing exchange rate. On the other side, you have no USD left and you need USD. You need USD more than I need EUR (now I have the time to go to the bank and exchange my USD for EUR at the official exchange rate). If you want to buy USD from me, the exchange won’t be 1:1, I will not sell 1 USD for, let’s say, less than 1.1 EUR.
As a result, EURUSD just went up to 1.1.

This is how the market moves. What moves out 2 players market also moves the real forex market.

Conclusions:

1. The exchange rates change all the time because the supply/demand changes every time. The exchange rate is just a mirror of supply/demand operations.

2. The exchange rates also change according to rumors. Let’s say I know the US prices, I know what exactly I want to buy from there so I know how many USD I need. But right before I check in at the airport I turn on the radio and hear a rumor: “The prices will raise in US this month by 10%!”.
Damn, I need at least 10% more USD, let’s sell my remaining EUR and buy more USD at once at a higher exchange rate if necessary. I need american goods so I need USD. On the other hand, let’s suppose I hear Ben speaking about money printing. Damn, the USD has no real value, I have to get rid of them, I won’t keep my savings in USD anymore, let’s sell my USD right now!
Right after that I hear Draghi talking about the danger of Greece default. Damn, EUR is not a safe currency also, but at least I hope US and Europe won’t go down at the same time, let’s sell my EUR and buy more USD.

3. When the overbought/oversold levels are reached, the retracement begins. The market never moves in straight lines. I only have USD and suddenly I need EUR, therefore I have to buy some EUR. At this point, the retracement begins.

4. The currencies have the tendency to trend in one direction or another because there is no perfect balance between supply and demand and it will never be.

5. When there are no rumors (fundamentals), the market is in range (it moves between the latest lower low and the latest higher high).

6. Sooner or later any level gets broken because supply/demand dynamics changes every time.

Now we have a basic image of the market (I tried to induce you a visual image because the brain works better with visual objects), in the following articles I will tell you my opinion about how we can speculate market movements in order to make money.

Thanks for reading!