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How Does the Currency Market Work?

The currency market intrigues a lot of new investors, but virtually everyone on this planet has participated in it in one way or another. The minute you exchange a currency for another, for example if you buy something online from abroad or visit another country, you’ve just traded money over the currency market. The currency, or forex (short for “foreign exchange”) market is made up of central banks and private institutions involved in the trade of different national currencies. This market is very different from the stock market, however, even though it has some similarities. Let’s take a closer look at how the currency market works and some of the forces that influence it.

How does the currency market work? 1 the currency market intrigues a lot of new investors, but virtually everyone on this planet has participated in it in one way or another. The minute you exchange a currency for another, for example if you buy something online from abroad or visit another country, you've just traded money over the currency market. The currency, or forex (short for “foreign exchange”) market is made up of central banks and private institutions involved in the trade of different national currencies. This market is very different from the stock market, however, even though it has some similarities. Let's take a closer look at how the currency market works and some of the forces that influence it.

Currency Pairs in Trading

You can trade almost any currency for another one over the foreign exchange market. This is done via currency pairs, such as USD/CAD (US dollar against the Canadian). Every currency pair has a price quote for the first currency in the pair against the second. When you trade a forex, you’re making a prediction whether that price will rise or fall. 

If you want to trade the Canadian dollar against the US dollar or other currencies, you should have no trouble finding a platform that provides this, but if you want to trade more exotic currencies like the South African Rand or the Malaysian Ringgit, you have to check if your broker offers those.

Currency Market vs the Stock Market

The biggest difference between the stock market and the currency market is the nature of what you’re trading. Stocks are shares of a company and when someone buys a share, they effectively become part owners of that company. When you’re trading currency, you’re trading a financial instrument that you can exchange for goods and services in an economy.

Currencies do not abide by the same rules that stocks do. Currencies don’t have to please investors and do not pay dividends. Currencies are also generally more volatile than stocks. This means that prices of currencies can fluctuate more within shorter timespans, which can provide opportunities for day trading, but also increases risk of losses.

Another major difference between the forex market and the stock market is that you can trade currencies 24/5. Forex assets are also much more liquid, meaning that you can complete trades much faster on the forex market than on the stock market. 

The Forces Influencing the Currency Market

The forex market is not influenced by the same forces as the stock market either. When looking at the value of a currency, you have to look at the country’s economy, political climate, and policies. Central bank announcements will usually have a direct effect on the price of the currency. If a country experiences political instability, then its currency will often see fluctuations.

Sometimes, more subtle factors will affect a currency. If we’re talking about a country whose economy relies a lot on one commodity, like oil, for instance, everything that happens with the price of oil can affect the country’s currency. The same goes if a project for a major pipeline gets nixed. 

Now that you know a bit more about the forex market and how it works, we suggest you start looking at the different methods and strategies you can use for trading it. Currencies are a potential useful addition to any portfolio and every trader should learn how to trade them if they want to benefit from this asset class.

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