The foreign exchange market facilitates international commerce in an increasingly globalized society.
FOREX is a contraction of the phrase "foreign exchange" and refers specifically to the international market for the sale and purchase of the world's currencies. The currency of a particular country has a specific value with respect to that of another country. The disparity in value between any two currencies is expressed by the exchange rate: the amount of one currency needed to buy one unit of another. Exchange rates have fluctuated on a daily basis since the 1970s and are a major trade concern for exporting countries. The FOREX market is also a source of speculation for investors seeking short-term trading opportunities with the potential for high profits.
History
The market for the exchange of the world's currencies and its effect on global economic relations came to the fore in 1944. The Bretton Woods Conference, which was convened to formulate a plan for international economic stability in the wake of World War II, instituted a system of specifically-fixed exchange rates. By 1971, the U.S. dollar moved away from the gold standard -- upon which this system was based -- and entered a fluid market in which its value was determined by international supply and demand. This "floating" model was adopted worldwide shortly thereafter, and remains the system by which currency is traded and exchange rates determined.
Exchange Rates
An exchange rate is the price of one unit of one currency in terms of another. For instance, if one U.K. pound sterling (GBP) is valued in the foreign exchange market at 1.5 U.S. dollars (USD), then the exchange rate would be written as 1.5 USD/GBP. This means that an individual who holds U.S. dollars and wishes to purchase f10 will have to pay $15.
Exchange Rate Fluctuations
Currency prices in the foreign exchange market are determined by supply and demand. As a truly global market, the foreign exchange market is open almost constantly. As a result, currency prices, or exchange rates, change from moment to moment according to the volume of currencies bought and sold at any given time. Exchange rates decline when large volumes of a currency are sold and vice versa. Similar to movements in stock prices, exchange rate movements are affected by natural disasters, international conflict, sociopolitical instability, as well as breaking news related to economic well-being.
FOREX and Global Trade
The foreign exchange market plays a pivotal role in the international economy where exports are concerned. The success of cross-border transactions are determined by the relative stability of the exchange rate between the currency of the exporter and that of the importing country. Even a slight unfavorable change in such an exchange rate can result in serious losses for an exporting country. This is because export prices are translated based on a market exchange rate which is prior to the actual exchange of the foreign payment.
Risks
As illustrated above, participants in the foreign exchange market assume a high level of risk whether their intentions are functional or purely speculative (i.e. day trading). Participants assume higher levels of risk the higher the amount of money they buy and sell. Speaking from a U. S. dollar point of view, this is because even the slightest change in an exchange rate can either cost or make thousands of dollars. Symptomatic of such risk, however, is the speculative opportunity to make astronomical profits in the foreign exchange market in a very short space of time.
