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If your business makes or receives international payments, you likely already know a thing about foreign exchange or Forex. You already understand how fluid it is, with the exchange rates between currencies rising and falling every day. Sometimes, it can seem as though the changes in exchange rates are arbitrary. But the better you understand Forex, the easier it is to preempt changes in exchange rates, and budget accordingly.
What’s more, business owners who are also investors may want to consider growing their investment portfolios with Forex. Here, we’ll look at everything you need to know about Forex in your business transactions and beyond.
What is Forex trading?
Forex is shorthand for foreign exchange – it’s an umbrella term used to describe the buying and selling of international currencies and their derivatives. Much of this, the kind with which you’ll likely have the most personal experience, is practical. International transactions between businesses and consumers, or private individuals exchanging money for overseas travel, are common examples of practical Forex.
However, the overwhelming majority of transactions are made by Forex traders who buy and sell strategically to turn a profit. The Forex market is the biggest and most liquid market in the world, with over $6.5 trillion exchanged every single day. That’s almost eight times more than the entire crypto market at its peak. So whether you’re a seasoned investor, or someone who trades internationally, it’s a good market to get to know better.
How does Forex trading work?
The Forex market is open 24 hours a day Monday to Friday. It is completely decentralized with lots of banks, investment firms, and brokers offering access to the market. Investors buy and sell currencies in relation to one another. These are called pairs. For instance, USD and EUR (US dollars and euros) are the most commonly traded pair in the world.
Instead of physically exchanging the currencies, however, investors pay for a position on a currency. Ideally, the currency they buy will strengthen by the end of the day. Or if they’re selling it, the currency against which they’re selling will weaken. Either way, investors make their profits on the difference. Movements in the market are driven by economic growth, interest rate differentials and good old-fashioned speculation.
There are several different types of Forex transactions.
Spot market deals are designed to be settled and delivered immediately. In trading terms, “immediately” means two business days (although USD / CAD trades can be completed within one business day). During holiday seasons, transactions can take much longer (up to six days). The day the transaction starts is called the transaction date. The day it is completed is called the settlement date.
Forward transactions are settled later than spot transactions. The spot rate is adjusted in increments called “forward points” that reflect the interest rate differential between the two markets. Forex forward transactions are tailormade contracts that can be settled on any business day.
Futures contracts are agreements between two parties for a certain amount of currency to be delivered on a set expiry date. Traders make their profit on the difference in value between when the contract was bought, and when it is sold.
Why does Forex matter to you and your business?
Like any investment, Forex can be used to grow your personal wealth, and mitigate the risk to your personal finances caused by fluctuations in business. Of course, like all investments, Forex comes with a degree of risk. But as your understanding of the market grows, you’ll be better positioned to avoid and mitigate risks.
If your business trades internationally, the knowledge gleaned from Forex trading could help you to better understand the implications of trade relations with different countries on your profit margins and cash flow.
We can help
If you’re interested in finding out more about forex, investments and all matters pertaining to your business finances, then get in touch with the financial experts at GoCardless. Find out how GoCardless can help you with ad hoc payments or recurring payments.