History of Forex – Money and Currency Exchange
Money, in its broadest sense, has always played a fundamental role since the earliest human societies. From the primitive form of barter trading goods for goods to metal coins, paper currency, and eventually digital money, the methods of exchange and valuation have undergone significant changes throughout history. One of the key aspects of the world of money is its exchange and conversion between different currencies. This process forms the foundation of the Forex or foreign exchange market.
How Does the Forex Market Work?
Supply and demand are the foundation of how the Forex market operates. Traders in this market aim to profit from exchange rate fluctuations by buying and selling currency pairs, seeking gains and avoiding losses. While this may seem simple on the surface, the reality is that complex mechanisms function behind the scenes in the Forex market. Some of the most important aspects include:
The Forex market operates through a decentralized and digital structure, allowing thousands of companies, banks, financial institutions, and individuals to trade directly or indirectly with one another. Unlike stock exchanges, Forex does not have a central exchange or marketplace. Instead, it is formed by a global network of liquidity providers (LPs), brokers, and trading platforms.
1. Liquidity Provision by Banks
Major international banks (such as JPMorgan, Citi, Deutsche Bank, etc.) act as liquidity providers (LPs). These banks are always ready to buy and sell currencies, feeding the market by quoting bid and ask prices. These prices constantly fluctuate and form the most fundamental layer of the market, known as the Interbank Market.
2. Price Transmission to Brokers
Forex brokers are connected to these major banks and receive their real time quotes. Some brokers pass these rates directly to the user (ECN/STP), while others execute the orders themselves by adding a small markup (spread), a model known as Market Maker.
3. Access for Traders
A user (retail trader) opens an account with a broker and, through platforms like MetaTrader, can view live currency prices. When the trader clicks buy or sell, their order is routed through the broker’s system to the liquidity market (or matched with the other side of the trade in the market maker model).
4. Order Execution
Order execution in financial markets depends on the type of broker you work with, and this has a significant impact on how your trades are carried out.
If the broker is of the ECN (Electronic Communication Network) type, your order is entered into a global liquidity pool. In this case, your order is matched and executed at the best possible price among various available offers in the market. This type of broker provides direct access to the interbank market and usually offers lower spreads, allowing traders to benefit from true market pricing. As a result, trades with ECN brokers are generally more transparent and executed faster.
On the other hand, if the broker is a Market Maker, the situation is somewhat different. In this model, the broker itself acts as the counterparty to your trade—meaning when you want to buy, the broker acts as the seller, and vice versa. Essentially, the broker is trading against you and sets the prices itself. These brokers may offer wider spreads but often provide faster order execution without requotes. However, this model may involve risks such as a potential conflict of interest, which traders should be aware of.
In both cases, once the order is placed, the trade is executed instantly, and the price on the relevant financial asset’s chart is updated. This means you can immediately observe price changes and make decisions based on real time information.
5. Global Coordination through Timing and Technology
To ensure this system operates continuously and around the clock, the Forex market is divided into four major global sessions: Sydney, Tokyo, London, and New York. This time zone coverage ensures that there is always an active market for executing orders. The FIX protocol and trading server infrastructures handle all these processes within milliseconds.
Advantages and Disadvantages of Trading in the Forex Market
The Forex market, or the foreign exchange market, is a vast and 24 hour arena for monetary exchanges, known for both its attractions and its challenges. In this market, traders buy and sell trillions of dollars' worth of various currencies every day. The appeal of the Forex market lies in its potential for significant profits, but like any other investment market, the risk of capital loss also exists. Before entering the world of Forex, it is essential to become familiar with its advantages and disadvantages.
Advantages of Trading in the Forex Market
The Forex market is a vast, 24 hour arena for foreign currency exchange, where traders execute a massive volume of transactions daily. This market offers significant opportunities for profit, but like any financial market, it also comes with its own set of risks.
- High Liquidity: Due to the enormous trading volume and the continuous presence of participants around the clock, the Forex market offers very high liquidity, allowing for the quick conversion of assets into cash.
- Easy Access: With an internet connected device and registration with a reputable broker, individuals can quickly enter the Forex market.
- Low Transaction Costs: Compared to other financial markets, the transaction costs in Forex trading are generally lower.
- Ability to Trade in Both Market Directions: Traders can profit from both the rise and fall of a currency’s value.
- 24 Hour Market: The Forex market operates around the clock, five days a week, giving users flexibility in trading times.
Disadvantages of Trading in the Forex Market
- Relatively High Risk: Currency price fluctuations can change rapidly, especially when using financial leverage, which can lead to significant losses.
- Psychological Stress: The fast paced and volatile nature of the market can cause psychological pressure and emotional decision making, which may result in losses.
Risk Management in the Forex Market
Risk management is a systematic process that helps traders identify, assess, and control potential threats. The goal of this management is to minimize possible losses and increase the likelihood of achieving favorable outcomes.
In the Forex market, risks are diverse, and understanding them along with using appropriate tools is the key to successful trading.
The main stages of risk management are as follows:
- Risk Identification: The first step in risk management is identifying all threats and factors that could impact capital. This is done through data analysis, experience, and analytical tools.
- Risk Assessment: After identification, the likelihood and severity of each risk must be evaluated to prioritize them appropriately.
- Risk Control: By applying various methods such as setting stop loss orders, using appropriate leverage, diversifying trades, and adhering to a trading plan, risk can be managed effectively.
The Forex market offers many opportunities for profit, but without proper awareness and risk management, the chance of losing capital is very high. Successful traders are those who understand risks and manage them intelligently.
Technical Analysis and Fundamental Analysis in the Forex Market
In the Forex market, there are two main approaches for analyzing and forecasting price movements: technical analysis and fundamental analysis. Each method has its own tools and frameworks, and understanding them is essential for traders.
Technical Analysis
Technical analysis is based on the study of past price fluctuations and trends. Traders attempt to predict future price movements by analyzing charts, price patterns, and various indicators. This approach assumes that all factors affecting the price are already reflected in the chart, and that history tends to repeat itself.
Technical analysis involves the use of indicators such as moving averages, trading volume, candlestick patterns, and other charting tools that help identify entry and exit points.
Fundamental Analysis
Fundamental analysis examines economic, political, and social factors that influence the intrinsic value of a currency. It includes the study of data such as interest rates, inflation, economic growth, trade balance, and central bank policies. The goal of fundamental analysis is to understand the reasons behind price movements and to evaluate the true value of currencies.
Differences and Applications
Technical analysis is more commonly used for short and medium term trading, while fundamental analysis is important for long term investments and gaining a deeper understanding of overall market trends. Most successful traders use a combination of both methods to guide their trading decisions.
Types of Traders in the Forex Market
The Forex market hosts a wide variety of traders, each operating based on their trading style, time frame, and objectives. Understanding these types helps traders find the approach that suits them best and improves their market analysis.
Day Trader
Day traders typically open and close their positions within the same trading day, profiting from short term market fluctuations. They usually rely on technical analysis and price charts to identify trading opportunities.
Swing Trader
Swing traders hold their positions for several days to a few weeks to take advantage of medium term price swings. These traders often use a combination of technical and fundamental analysis to make informed decisions.
Position Trader
Position traders hold their trades for months or even years, focusing on long term market trends. Fundamental analysis plays a major role in their decision making process, and their goal is long term investment.
Other Types of Traders
Some traders adopt hybrid or specialized strategies, which may include scalping, algorithmic trading, or news based trading. Choosing a trading style that aligns with one's personality, goals, and risk tolerance is crucial for long term success.
What Is the Role of Brokers in Forex?
In the decentralized Forex market, retail traders (i.e., individuals like you and me) do not have direct access to the interbank market. This is where brokers (Forex Brokers) come into play. Brokers act as intermediaries, providing ordinary users with access to live pricing, order execution, and market liquidity.
1. Intermediation Between Trader and Global Market
Brokers play a key role in facilitating trades between individual traders and the global market. Essentially, a broker receives buy and sell orders from traders and, depending on its business model, either connects them to the global market or acts as the counterparty itself.
InECN or STP brokers, user orders are directly transmitted to a liquidity network that includes major banks and financial institutions. This approach enables highly transparent trades at real market prices, allowing traders to benefit from global market conditions.
In contrast,Market Maker brokersact as the counterparty to a trade meaning when you buy, the broker sells, and vice versa. While this model may offer faster order execution, it can also lead to potential conflicts of interest between the broker and the trader.
2. Providing Real Time Pricing
Brokers are responsible for supplying real time asset prices. They receive these prices from multiple liquidity providers and display them to traders via platforms like MetaTrader.
The prices provided include two main quotes:
Bid– the price at which you can sell
Ask– the price at which you can buy
The difference between these two is known as thespread, which is typically the broker’s main source of income and plays a significant role in trading costs.
3. Order Execution and Risk Management
Once a trader places an order, the broker processes it through its system and executes it at the best available price according to its operating model. Depending on the size and type of the order, some brokers may either absorb part of the risk themselves or transfer it to the market.
4. Providing Additional Services to Traders
Brokers are not just technical intermediaries they also offer a wide range of services, such as:
- Trading platforms (e.g., MetaTrader)
- Demo accounts
- Leverage for trading with smaller capital
- Technical analysis tools
- News and economic data
- Education and customer support
As a result, without brokers, access to the Forex market for everyday individuals would be virtually impossible. Choosing a reputable broker with a transparent business model is crucial to a trader's success, as the broker’s performance directly impacts order execution speed, trading costs, and overall user experience.
How Are Trades Executed in the Forex Market?
When you, as a financial participant or trader in the Forex market, press the buy or sell button, complex mechanisms are activated behind the scenes to register your order in just a few milliseconds. These mechanisms include:
Order Placement by the Trader
Orders are placed either manually or automatically through a trading platform (such as Meta Trader). You can specify the order type, trade volume, Take Profit, Stop Loss, and other details.
Types of Orders
The Forex market offers various order types, each with its own characteristics and execution method. Traders use them based on their strategy and market conditions:
- Market Order
- Limit Order
- Stop Order
Risk management tools such asStop LossandTake Profitallow traders to control losses and lock in profits.
Order Processing on the Broker’s Side
Once the order is submitted, depending on the broker type, it follows one of two paths:
- InECN/STP brokers, the order is routed to the liquidity network and executed at the best available price among liquidity providers.
- InMarket Maker brokers, the broker itself acts as the counterparty and executes the order internally within its own system.
Final Execution and Trade Confirmation
After execution, the trader’s position is opened and the trade is officially recorded. Details such as execution price, spread, commission, and execution time are stored.
Factors Affecting Order Execution Quality
- Internet speed and ping to the broker's server
- Type of trading account (ECN or standard)
- Market conditions (news events, high volatility)
- Real time liquidity of the currency pair
Risks of Investing in Forex
The Forex market, with its daily trading volume in the trillions of dollars, offers tempting opportunities for profit. However, this highly volatile market also carries significant risks, and fully understanding them is essential before entering this arena.
Exchange Rate Risk
Exchange rate risk, also known as currency risk, refers to the potential loss in investment value due to fluctuations in exchange rates. This risk affects anyone involved in foreign currency transactions, including companies, investors, and individuals.
There are various forms of exchange rate risk, and it can have a major impact on companies and investors. For example, if a company holds assets in a foreign country, a decline in that country's currency value could result in substantial losses for the company.
Interest Rate Risk
Fluctuations in interest rates are a key risk factor in financial markets. Understanding interest rate risk and its impact on the value of fixed income securities is essential for investors and financial managers when making strategic decisions.
Nature of Interest Rate Risk
Interest rate risk refers to the potential for unfavorable changes in the value of fixed income investments, such as bonds, in response to interest rate movements. The inverse relationship between interest rates and bond prices has significant implications for investment portfolios.
Complexity and Need for Specialized Knowledge
Successful Forex trading requires a deep understanding of economic factors, technical analysis, and risk management principles. Many new investors enter the market with the expectation of quick profits, but without the necessary knowledge and experience, they are likely to face significant losses. Understanding market dynamics and developing effective trading skills takes time and considerable effort.
Psychological Stress
The fast paced and volatile nature of the Forex market can lead to high levels of psychological stress for traders. Emotions such as fear and greed can interfere with rational decision making and result in costly mistakes.
However, through proper education and awareness, you can prepare yourself mentally and emotionally for entering the Forex market. One of the best free resources available to the public, including Iranian traders, is the"Zero to Thousand"course. By watching this course, you can work toward achieving your goals and aspirations.
Forex Market Hours
The Forex market operates 24 hours a day, 5 days a week. However, volatility and liquidity vary throughout the day. Understanding the best trading hours in Forex is crucial for maximizing profits and minimizing risks.
What Is Liquidity in the Forex Market and How Is It Provided?
Liquidity in the Forex market refers to the availability of a large number of buyers and sellers for any currency pair at any given moment. This characteristic is one of the most crucial factors for the success and efficiency of financial markets.
When market liquidity is high, trades are executed more quickly, and traders can place orders without delay and at fair prices. Additionally, the spread the difference between the Ask (buy) and Bid (sell) prices tends to be narrower, which helps reduce trading costs.
High liquidity also helps prevent abnormal market volatility. In markets with low liquidity, prices may experience sudden spikes, increasing risk for traders. Therefore, sufficient liquidity contributes to market stability, reduces unexpected risks, and enables traders to operate with greater confidence.
Who Provides Liquidity?
Liquidity providers are major market participants who constantly place high volumes of buy and sell orders in the market. They include:
- International bankssuch as JPMorgan, Citi, Deutsche Bank
- Large financial institutions and hedge funds
- Major brokers and ECN (Electronic Communication Network) networks
- Central banksunder specific conditions (e.g., currency market intervention)
Brokers connect to these entities to supply real time pricing and execute trades. The more liquidity providers a broker is connected to, the higher the liquidity they can offer to their clients.
The Relationship Between Liquidity, Time, and Currency Pairs
Liquidity in the Forex market is not constant and is influenced by various factors such as trading time and the type of currency pair.
One of the most important influencing factors is the working hours of global markets. Especially when the London and New York markets overlap, liquidity reaches its highest level. During this time frame, trading volume increases, and better opportunities for quick entry and exit from trades are provided.
On the other hand, the type of currency pair also plays an important role in the level of liquidity. Major pairs like EUR/USD, GBP/USD, and USD/JPY have very high liquidity, meaning that trades in these currencies are executed quickly and with minimal spread.
However, exotic or emerging market pairs usually have lower liquidity and therefore face higher volatility. This makes trading in these markets riskier, and order execution may be delayed or occur at less favorable prices.
Overall, being aware of the relationship between liquidity, time, and the type of currency pair can help traders make better decisions in selecting their trading time and instruments.
Why Is Liquidity Important?
Liquidity is considered one of the vital factors in the quality of Forex market trades, and its importance is reflected in several key aspects.
Firstly, high liquidity leads to reduced spreads; that is, the difference between the buying and selling price will be smaller, which means lower trading costs for traders.
Secondly, with sufficient liquidity, orders are executed faster, and traders can enter or exit the market at their desired time without facing delays or unfavorable pricing.
Additionally, high liquidity reduces the likelihood of slippage. Slippage occurs when a trader's order is executed at a different price than expected, which usually happens due to a lack of liquidity in the market.
On the other hand, sufficient liquidity reduces sudden and severe market fluctuations, which in turn reduces unexpected risks for traders.
However, during times such as major economic news releases or bank holidays, liquidity decreases, and this can lead to sharp and sudden price jumps. Therefore, traders must carefully plan their trade timing to avoid risks arising from reduced liquidity.
Is Forex Only for Trading?
No, the Forex market is not limited to traders and trading activities. Long term investments can also be made in this market. However, due to Forex's reputation for price volatility and the relatively easier process of learning trading and earning reasonable profits compared to investing, most people tend to prefer trading over long term investing in Forex with the hope of earning significant profits.
Investing in Forex: Beyond Trading
Forex is not just a place for daily or short term trading; it can also be used for medium and long term investments. Investing in Forex can be done in two ways: directly or indirectly, each with its own characteristics and requirements.
Direct and Indirect Investment in Forex
In direct investment, you personally and actively enter the Forex market and execute trades yourself. In contrast, in indirect investment, you allocate your capital to professional managers or Forex investment funds who trade on your behalf, and you benefit from the profits.
Direct Trading in the Market
Forex trading brokers allow you to enter the Forex market directly and manage your own trades. Typically, using platforms like Meta Trader 4 or 5, or a broker’s proprietary platform, you can open and close trades. These brokers provide you with analytical tools, various charts, order types, and risk management features so you can operate effectively in the market. These types of brokers are suitable for all trading styles, including day trading, short term trading, swing trading, and even long term investing.
Investing in Forex: Professional Capital Management
On the other hand, Forex investment brokers, who usually offer services such as managed accounts or PAMM accounts, allow you to entrust your capital to professional managers who trade on your behalf. In this case, you do not interact directly with the trading platform and do not open or close trades yourself. These brokers focus more on providing investment services, and your profits and losses depend on the performance of the professional managers. This type of broker is suitable for those who lack the time or expertise for trading but still want to benefit from the Forex market.
Key Differences Between Trading and Investment Brokers
In summary, the key differences between these two types of brokers are as follows: with direct trading brokers, you manage the trades yourself and have full access to the trading platform, requiring a higher level of trading knowledge and giving you full control over your trades.
However, in investment brokers, the management of trades is handled by professional managers and the broker’s representatives. As an investor, you typically do not have direct access to the investment platform, or you only receive and monitor performance reports provided by the investment broker. This method of investing requires little trading knowledge, and control over the trades is limited or nonexistent. Moreover, the risk and return in this approach depend directly on the performance of the managers or the investment broker’s representatives.
