Foreign exchange, or Forex, is the conversion of one country's currency into that of another. In a free economy, a country's currency is valued according to factors of supply and demand. In other words, a currency's value can be pegged to another country's currency, such as the U.S. dollar, or even to a basket of currencies. A country's currency value also may be fixed by the country's government. However, most countries float their currencies freely against those of other countries, which keeps them in constant fluctuation.

The value of any particular currency is determined by market forces based on trade, investment, tourism, and geo-political risk. Every time a tourist visits a country, for example, he or she must pay for goods and services using the currency of the host country. Therefore, a tourist must exchange the currency of his or her home country for the local currency. Currency exchange of this kind is one of the demand factors for a particular currency. Another important factor of demand occurs when a foreign company seeks to do business with a company in a specific country. Usually, the foreign company will have to pay the local company in their local currency. At other times, it may be desirable for an investor from one country to invest in another, and that investment would have to be made in the local currency as well. All of these requirements produce a need for foreign exchange and are the reasons why foreign exchange markets are so large.

Foreign exchange is handled globally between banks and all transactions fall under the auspice of the Bank of International Settlements.

(For more on this topic, see our Forex Tutorial.)

  1. What are the goals of covered interest arbitrage?

    The goals of covered interest arbitrage include enabling investors to trade volatile currency pairs without risk as well ... Read Full Answer >>
  2. How do I close a long position in forex?

    Closing a long position in forex trading depends on whether you are using a broker operating under U.S. trading regulations. In ... Read Full Answer >>
  3. Where did the term 'pip' in currency exchange come from?

    The term pip is an acronym for percentage in point or price interest point. It measures a unit of change within a pair of ... Read Full Answer >>
  4. How do changes in national interest rates affect a currency's value and exchange ...

    All other factors being equal, higher interest rates in a country increase the value of that country's currency relative ... Read Full Answer >>
  5. What is the difference between pips, points, and ticks?

    Point, tick and pip are terms used to describe price changes in the stock market and other markets. While traders and analysts ... Read Full Answer >>
  6. What is the difference between extensive margin and intensive margin in economics?

    Trading on margin is not commonly done in stock trading except by professional investors and institutional traders. However, ... Read Full Answer >>
Related Articles
  1. Forex Education

    Explaining Uncovered Interest Rate Parity

    Uncovered interest rate parity is when the difference in interest rates between two nations is equal to the expected change in exchange rates.
  2. Forex Education

    Top 6 Most Tradable Currency Pairs

    The most frequently traded currency pair is the euro/U.S. dollar. The euro is the base currency in the pairing, while the dollar is the quote currency.
  3. Forex Fundamentals

    How to Buy Chinese Yuan

    Discover the different options that are available to investors who want to obtain exposure to the Chinese yuan, including ETFs and ETNs.
  4. Forex Education

    9 Tricks Of The Successful Forex Trader

    These steps will make you a more disciplined, smarter and, ultimately, wealthier trader.
  5. Forex Strategies

    3 Simple Strategies For Euro Traders

    Euro traders can execute three simple but effective strategies that take advantage of repeating price action.
  6. Forex Education

    4 Of The Most Popular Traded Currencies

    Every day, trillions of dollars trade in the forex market. Here are a few of the most popular currencies, and some characteristics for each.
  7. Economics

    Currency Swap Basics

    A currency swap involves two parties exchanging a notional principal and interest to gain exposure to a desired currency.
  8. Forex Fundamentals

    3 Ways To Forecast Currency Changes

    Forecasting exchange rates can help minimize risks and maximize returns. Here are three popular methods for forecasting exchange rates.
  9. Investing Basics

    Quit Your Job To Trade Stocks

    Changes in technology have turned trading into a career field that’s easy to enter. But staying in it is a different story.
  10. Investing Basics

    Should You Trade Forex Or Stocks?

    Deciding whether to trade stocks, foreign exchange or futures contracts typically comes down to risk tolerance, account size and convenience.
  1. Currency

    Currency is a generally accepted form of money, including coins ...
  2. Transfer Risk

    The risk that a local currency cannot be converted into the currency ...

    See LIBOR
  4. WM/Reuters Benchmark Rates

    Spot and forward foreign exchange rates that are used as standard ...
  5. Exchange Rate

    The price of a nation’s currency in terms of another currency. ...
  6. Open Position Ratio

    The percentage of open positions held for major currency pairs ...

You May Also Like

Hot Definitions
  1. Take A Flier

    The slang term for a decision to invest in highly speculative investments.
  2. Bar Chart

    A style of chart used by some technical analysts, on which, as illustrated below, the top of the vertical line indicates ...
  3. Take A Bath

    A slang term referring to the situation of an investor who has experienced a large loss from an investment or speculative ...
  4. Black Friday

    1. A day of stock market catastrophe. Originally, September 24, 1869, was deemed Black Friday. The crash was sparked by gold ...
  5. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  6. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
Trading Center