Forex is an acronym for Foreign Exchange, which involves exchanging currencies of various countries of the world either for business needs or for profit making due to the fluctuation in their values. So the rate at which one can buy or sell a currency is called exchange rate for that currency which shows its value as compared to currency being used in its exchange. This exchange rate represents the amount of currency you want to buy or sell in exchange of amount of currency you are having at the moment. For example, you want to buy Egyptian Pounds by paying in USD then you will see its exchange rate which is around 1:5.5, which means that you will get 5 and half Egyptian Pounds for 1 US dollar.
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Forex exchange rate doesn’t stay the same. It experiences continuous fluctuations depending upon various factors important in determining the value of certain currency. On the basis of these fluctuation and stability in forex exchange rate, it can be divided into a couple of categories: fixed and floating exchange rate.
Fixed Forex Exchange Rate (Pegged)
As the term indicates, this type of forex exchange rate stays the same for longer time period and also called pegged exchange rate. Its value is set by central bank of government which is considered responsible for stabilizing demand and supply of its currency. The exchange rate is calculated in relation to USD mostly.
The purpose for keeping the exchange rate fixed, is to maintain a balance between supply and demand of a currency. Central bank sells or buys its own currency for this purpose. As it holds high foreign reserves, therefore it is convenient to absorb extra currency from forex market or supply required amount in order to keep the business running smoothly. This rate stays unaffected by ever-changing exchange rate of forex market.
Floating Exchange Rate (Self-Correcting)
Floating or fluctuating exchange rate changes many times during the day depending upon its demand and supply in forex market. These fluctuations make traders come to invest in forex business so that they can generate profit by buying currencies at lower rate and selling at higher rate. Private market not central bank is considered responsible for setting floating exchange rate.
This kind of exchange rate is also called self-correcting as it has ability to correct itself according to the changing scenario in the market. Suppose if demand for a certain currency decreases in forex market, it influences the value of imports and increases their overall cost. In such situation, the demand for local products increases to compensate the inability to invest into expensive imports. This leads towards creating employment opportunities. So the whole setup adjusts with the change in the demand or supply of currency.
So if you are intending to invest in forex business then you need to keep a vigilant eye over floating exchange rate which will determine the potential of profit you can generate by investing certain amount into the money making venture of forex trading.