About Forexwhat are the currencies?
Forex is an acronym for the words foreign exchange, also known as the spot market.
A currency is money accepted as a means of exchange for goods and services and is the basis for trade. Currency is generally identified as a legal tender issued by a government on trust basis, and is circulating in an economy. Nowadays, new forms of money known as cryptocurrencies, which includes bitcoin and dogecoin have become part of the currency market.
How currency exchange works
Before we talk about how currency exchange works, we first have to understand what is meant by exchange rate. Exchange rate is the price a countries currency can be swapped for another countries currency; hence currencies are traded in pairs e.g. buy a currency and simultaneously sell another.
The first currency in a pair is the base currency, while the second is the counter currency.An example is the EURUSD currency pair, with EURO being the base currency and USD being the counter currency. Talking about price, it is also important to note that currency pair prices also come in twos, which are the ask price and the bid price.
Using the most traded currency pair EURUSD as an example, the EURUSD pair may be quoted thus 1.2148/1.2150. The first price is the bid price while the second price is the ask price. To place a buy order on the EUR/USD currency pair, a trader is offered the ask price, and if s/he wants to place a sell order, s/he is offered the bid price. The bid price is often shown on the charts but be mindful of the ask price if you noticed as a newbie you are not given the bid price. The difference between the ask and bid price is called a spread, which is usually the brokers commission on trades.Let’s assume the trader bought some EUR/USD and the exchange rate increases it means s/he is making profits because the value of the Euro increased and vice versa. Placing a short (downward) operation on EUR/USD means we are selling euros and buying dollars, so if the exchange rate drops we make profit because the dollar has increased in value and vice versa
Forex is considered as the most liquid financial market worldwide: liquidity is the volume of purchase and sale considered at a specific time, averaging over $3 trillion a day. These high exchange rates of forex can’t be compared to those of other financial markets, and this is why it draws the attention of all traders.
The high level of liquidity of forex makes for a considerable ease of execution, because it’s always easy to find a counterpart interested in buying or selling our currency.
There are other important advantages that this liquidity provides to the market: it’s predictable and less influenced, since even a substantial exchange volume creates small oscillations.
Another advantage of forex is that it’s an ever-active market, even at night as it’s open 24 hours a day from Sunday 22:05 GMT (opening of the Asian market) to Friday 21:50 GMT (closing of the US market).
The main currency pairs
All currencies are divided into three macro groups: Major, Cross, and Exotic pairs.
Major currency pairs include the currencies that have the US dollar either as their base or counter currency, namely:
- Euro / U.S. Dollar (EUR / USD)
- US Dollar/ Japanese yen (USD / JPY)
- Great British Pound / US Dollar (GBP / USD)
- US Dollar / Swiss franc (USD / CHF)
- New Zealand Dollar/ US Dollar (NZD / USD)
- Australian Dollar / US Dollar (AUD / USD)
- US Dollar / Canadian Dollar (USD / CAD)
These pairs are often referred to as global currencies or otherwise known as reserved currencies, because they are generally accepted for trade around the world.
Cross currency pairs are those with their base or counter currency as Great British pound, Japanese Yen and Euro, without the US dollar, namely:
- Euro / Great British Pound (EUR / GBP)
- Euro / Japanese Yen (EUR / JPY)
- Great British Pound / Japanese Yen (GBP / JPY)
- Great British Pound / Swiss franc (GBP / CHF)
- Euro / Swiss franc (EUR / CHF)
- Euro /Canadian Dollar (EUR / CAD)
- Euro / Australian Dollar (EUR / AUD)
- Euro/New Zealand Dollar (EUR / NZD)
- Great British Pound/ Australian Dollar (GBP / AUD)
Exotic currency pairs are currencies of emerging countries or strong currencies of small economies such as Hong Kong or Singapore:
- Euro / Turkish Lira (EUR / TRY)
- US Dollar / Swedish Krona (USD / SEK)
- US Dollar / Norwegian Krone (USD / NOK)
- US Dollar / Danish Krone (USD / DKK)
- US Dollar / South African Rand (USD / ZAR)
- US Dollar / Hong Kong Dollar (USD / HKD)
- US Dollar / Singapore Dollar (USD / SGD)
- US Dollar / Mexican Peso (USD/MXN)
the Analyst's answerJean Grossett - Financial analyst
How was the forex born? …In the early 1970s, currency price of most states (countries) were determined by their gold reserves. During this period, gold was the general exchange standard. Every state had its own currency expressed in gold ounces. Sometime around 1971, the US did not have enough gold in it reserve to cover for the U.S dollars that the foreign central banks had in their reserve, which lead to the gold standard being abandoned. Floating exchange rates were introduced, such that currency prices were determined based on supply and demand. Enter the international currency market, “Forex”.
In the early days of the foreign exchange markets, the only participants involved were very large banks and financial institutions. The invention of the internet has offered private traders and individuals the opportunity to trade from any location in the world, and at the same time on margin. Nowadays we see brokers, allowing traders to even start trading even with a deposit of as low as $50 US Dollars.
the Manager's answerRobert Danvil - Investment Manager
Forex trading is a zero sum game, when you place a buy order, there has to be some other trader willing to sell at the price and quantity you bought. Hence one traders win is another trader’s loss.
Everyone is generally involved in the forex markets, either directly, indirectly or both. When you buy a product on amazon, or buy a commodity that was imported into your home country, you are involved in some form of foreign exchange.
Some conversion process is taking place between your debit/credit card issuer and Amazon. Also, companies in order to mitigate against volatility risks in exchange rates may decide to hedge their position/investment.
Retail traders or prop traders also participate in forex trading, however this time around they are direct involved. They come into the markets with the aim to profit from the fluctuations in the exchange rates, as well as keep the markets stable.
the Mentor's answerNicholas Kihn - Forex coach and mentor
An Hypothetical forexExample?…Assuming a hypotheticalscenario whereby we have $100.00 and we are at the airport going on a holiday to France. For convenience, we decided to exchange our US dollars for euros, let’s say we were quoted an exchange rate of 1euro=2U.S dollars for simplicity sake. In order to get our money exchanged to euro, we have to simultaneously buy the euro by selling off our U.s dollars.
If 1euro = 2 U.S dollars
X euro= 100 U.S dollars
Where“X” is the amount in Euro we are solving for. This goes on to be 100/2 =50 Euro. This implies that our $100 U.S dollars at the exchange rate of 1Euro = 2U.S dollars is 50Euro.
Still using our hypothetical example, let’s assume that our flight was finally cancelled, after waiting at the airport for 4hrsdue to unfavorable weather conditions. We decided to cancel the trip all together, and asking for a new exchange rate from the Berea de change we were given a quote of 1euro = 5U.S dollars. If we decide to buy back our U.S dollars, multiplying our 50euro by the 5 U.S dollar exchange rate, we will discover that we arrive at $250.00. This amounts to a profit of $150.00, 150% profit. Please note that if the exchange rate was quoted as 1Euro = 1U.S.dollars, we would have been in a loss of$50.00 U.S dollars after buying back our U.S dollar and selling off the 50Euro.