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Simplifying the Foreign Exchange Market

Many people are in the dark about the foreign exchange market. To them it is some abstract and complicated concept that seems too daunting and hard to understand. But let us first look at the terminology. What does the term 'foreign exchange' imply? Well, if we look at the term itself, we can clearly see that this happens when one currency is traded or exchanged for another.

The foreign exchange market exists as a necessary consequence of international trade. Or to put it simply, it exists because different countries trade with each other. For example, we all know about import and exports. Imports are goods or services we buy from other countries. Whereas exports are good or services we sell to other countries. This exchange of goods and services is what we call international trade.

But let us give a concrete example.

For example, practically all countries buy oil from Arabian countries. Let's take for example Mexico. Mexico buys oil from Saudi Arabia. However, Saudi Arabia will only accept payment either of its own currency or in US currency, which is accepted worldwide. Thus, the Mexico will exchange its own currecy for either Arabian riyals or US dollars. And thus, there is foreign exchange trading. In this example, we can also see that the demand for US dollars or Arabian Currency increases as more and more people sell their own currencies to buy these currencies because of the need to buy oil. As the demand for these currencies increase, so does their value.

The price of one currency in terms of another, is what we call the foreign exchange rate. The buying and selling of different currencies is what we call the Foreign Exchange Market or the FX market.

Now, when we say, 'market', we often picture a particular place or location or establishment. But in this case this isn't so. There is no physical or actual place or location. Rather, it consists of traders from all over the world connected by telephone lines or the internet. In other words, the traders are brought together by modern communication systems.

There are three main centers of trading, which handle the majority of all foreign exchange transactions - United Kingdom, United States, and Japan. Transactions in Singapore, Switzerland, Hong Kong, Germany, France and Australia account for most of the remaining transactions in the market. The Foreign exchange market is fast paced and quite unpredictable as the currency rate changes at an overwhelming speed. And though there is no exact place or location, it is considered to be the largest market in the world.

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