Forex trading is the process of buying a specific currency and selling it later hopefully at a profit. This is partly true, but not the whole truth.
If you walk into a bank or a forex bureau to exchange currency, you’ll deposit your initial currency and in exchange walk out with a different currency. Say you walk in with Kenya shillings and walk out with American dollars. In this case, you are receiving the actual delivery of your product. You buy US dollars with Kenya shillings and walk out of the deal with an actual product (USD).
In the online forex trading space however, currencies are bought and sold, but no actual delivery of the product is made. Instead, when you buy a currency from a broker online, what is sold to you is a virtual asset and a binding contract that the broker will take back his virtual asset once you, the forex broker is ready to sell the virtual asset back to the broker at a later date. This means you will not receive actual delivery of the bought asset.
As a forex trader, what you are trading online is not an actual asset. You trade a derivative of an asset. A derivative is a financial agreement between the forex broker and forex trader that shows that both parties have agreed to derive the value of a virtual product based on the value of an underlying asset.
If you want to buy Euros for example, you enter into a contract with the broker that states that you have bought from him virtual Euros. The value ascribed to the virtual Euros is tied to the actual value of the underlying asset. This means that the virtual assets have no value of their own. They derive their value from the value of the assets from which they are linked.
In forex trading, this derivative is called “Contracts for Difference” (CFDs). With CFDs, only virtual assets are traded and there is no actual delivery of an asset. You buy or sell a particular virtual asset whose value is derived from the value of the real asset in the market. For example, if you want to buy Euros, the broker will sell virtual Euros at the present price of Euros in the market. You enter into an agreement with the broker to buy Euros, which you’ll sell at a later date. Depending on the price fluctuations of the real underlying asset, you will either make gains or losses when you sell back the Euros to the broker.