Forex trading can simply be defined as the trading of foreign currencies. The exchange of foreign currency is important, especially when doing business with a foreign company, because you have to use foreign currency to conduct the transaction. For example, a company in the United States that is trying to buy wine from a French company has to convert U.S. dollars to euros, in order to complete the transaction.
The same goes for travelling to foreign countries, in some places, your country’s currency might be accepted, but more often than not, you will have to convert your foreign currency into the local currency used in the country that you are visiting.
The fact that people have to exchange currency when conducting transactions internationally or travelling internationally, is the reason that the foreign exchange market exists, and also the reason that it is the largest and most liquid financial market in the world. According to the Bank for International Settlements, the forex market trades over $5 trillion per day, which dwarfs all the other financial markets, including the stock exchange.
What makes the forex market different from the other financial markets, is the fact that there is no central market where transactions take place, like Wall Street. Instead, all forex transactions are conducted electronically, meaning that forex traders around the world conduct transactions over computer networks. The fact that all trades are done electronically is why the market is open 24 hours a day, five and a half days a week. Since the currencies are being traded across almost every time zone in the world, the market is very active at any time of the day, and the price quotes change constantly.
Foreign exchange is traded in three ways, the forwards market, futures market and the spot market. The spot market is the largest of the three markets, because it is the asset that futures and forwards market are based on. The futures market used to be the most popular, because individual investors were allowed to trade on it. Technological advancements, which led to the trades being done electronically, led to a surge in activity in the spot market, which turned it into the preferred market of individual investors and speculators. Whenever you hear people talking about the foreign exchange market, they are most likely referring to the spot market. The futures and forwards markets might not be as popular as the spot market when it comes to individual investors, but it is popular with companies that want to hedge their customized forex trading strategies on a specific future date.