The foreign exchange market (currency, forex, or FX) market is where currency trading takes place. It is where banks and other official institutions facilitate the trading of foreign currency. FX transactions typically involve one party purchasing a quantity of one currency in exchange for paying a quantity of another via forex broker.
The foreign exchange market exists wherever one currency is traded for another. It is by far the largest market in the world, in terms of cash value traded, and includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions. Retail traders (small speculators) are a small part of this market. They may only participate indirectly through brokers or banks and may be targets of forex scams.
Now, the FX market is one of the largest and most liquid financial markets in the world, and includes trading between large banks, central banks, currency speculators, corporations,governments, and other institutions. The average daily volume in the global trading of foreign currency and related markets is continuously growing.
Now question arises how forex works? The main purpose of forex market is to facilitate trade and investment. The need for a foreign exchange market arises because of the presence of multifarious international currencies such as US Dollar, Pound Sterling, etc., and the need for trading in such currencies. Market participants are  Banks, Commercial companies, Central banks, Hedge funds as speculators,  Investment management firms,  Retail foreign exchange brokers,  Non-bank Foreign Exchange Companies, Money Transfer and Remittance Companies.
Fluctuations in Forex rates is calculated in terms of floating exchange rate system and theories involved are (a) International parity conditions, (b) Balance of payments model, (c) Asset market model.
The several Economic factors which affect the forex rates are Government budget deficits or surpluses, Balance of trade levels and trends, Inflation levels and trends, Economic growth and health, Productivity of an economy.
The Foreign Exchange market is an international exchange market in the world, with a daily average turnover of approximately from 1.5 trillion to 2.5 trillion US dollar. Hundreds of thousands of individuals have already joined the Forex market. A FOREX broker needs to be associated with a large financial institution such as a bank in order to provide the funds necessary for margin trading.
The foreign exchange market has several unique features like trading volume, the extreme liquidity of the market, the large number and variety of traders in the market, its geographical dispersion, its long trading hours - 24 hours a day, the variety of factors that affect exchange rates.
Forex Brokers earn money by setting a spread i.e. the difference between what a currency can be bought at and what it can be sold at.
Currencies are always traded in pairs like the US dollar against the Japanese yen, or the English pound against the euro. Every transaction involves selling one currency and buying another, so if an investor believes the euro will gain against the dollar, he will sell dollars and buy euro’s.
The potential for profit exists because there is always movement between currencies. Even small changes can result in substantial profits because of the large amount of money involved in each transaction. At the same time, it can be a relatively safe market for the individual investor. There are safeguards built in to protect both the broker and the investor and a number of software tools exist to minimize loss.