Foreign Exchange trading consists of buying and selling currencies in order to profit from the evolution of their relative values. The market for forex trading is the most liquid in the world, which means that one can buy or sell almost any currency around the clock, most days of the week. The Forex market begins its cycle with the opening of markets in Sydney, Australia. It continues through Tokyo and Europe, and closes with the end of trading in the USA. Placed on the Greenwich clock, 5 pm local time in Tokyo (closing time) is 9 AM the next day in Frankfurt (opening time).
The number of currencies in the world is in the hundreds. To differentiate them each has a 3-letter abbreviation. Thus, the US Dollar is the USD, the Euro – EUR, the Pound Sterling – GBP (Great British Pound), the Swiss Franc is CHF, and so on. These are then divided into major currencies – those belonging to the major economies (US, Japan, the Eurozone, the United Kingdom, Canada, Australia, Switzerland and New Zealand). The rest are minors (South African Rand – ZAR, the Hong Kong Dollar – HKD, the Mexican Peso – MXN …).
Currency trading takes place on two currencies each time – one being sold and the other bought. Thus each trade is described in terms of the two 3-letter currencies delineating the pair (EUR-USD, GBP-JPY …). These currency pair combinations are ALSO divided into three – Major pairs, Minor pairs and Exotic pairs. Major pairs are those that include the US Dollar – EURUSD, USDJPY, GBPUSD, USDCAD, USDCHF, AUDUSD and NZDUSD. Minor pairs are various combinations of major currencies (EURGBP, GBPAUD, NZDJPY, and so on). Exotic pairs are usually comprised of a major currency (including the USD) and a minor one – EURTRY, USDNOK… the variety is immense.
FOREX Terms & Units
The ratio of currency values in the pair equals the value of the pair. To compute this, we differentiate between the first currency mentioned in the pair – the BASE currency, and the second – the COUNTER currency. The value of the pair equals the amount of COUNTER currency required to buy or received for selling one unit of the BASE currency. Thus, if the exchange rate for the EURUSD is 1 Euro=1.4 USD, then the value of the EURUSD equals 1.4. This value is usually described until the fourth place after the decimal point (sometimes 5, and in the case of the Japanese yen – 2). The unit in that 4th place is called a PIP.
When exchanging currencies – even at a money changer – three values are usually quoted: the middle value is the exchange rate as determined by central banks, the higher value is the rate at which one buys the pair (buys the BASE, sells the COUNTER currency) and the lower value is that at which one sells the pair (sells the base, buys and receives in exchange COUNTER currency). Clearly, what that means is that if one were to simultaneously buy and sell the pair, one would automatically lose the difference. This difference is called the SPREAD, and it’s the profit the money changer makes or the fee the broker takes for each exchange in return for client support, education and platform access.
As mentioned, the forex market is extremely liquid, or – in other words – large. As in physics, the weightier an asset, the harder it is to move. The daily volume of the forex market is measured in the trillions – remember, it includes every single trade made that requires the exchange of monies between two nationalities, and that includes inter-national trade, inter-bank transactions, etc. … not just tourists. As a result, it is very difficult to change the relative values of currency pairs. Thus, these changes are measured in pips – 1/10,000s of a currency unit at a time.
Consequently, to achieve any meaningful profit in the forex market, one must invest huge sums of money in order to take advantage of these miniscule movements. Since most retail traders cannot invest such sums, forex investments are leveraged by brokers. This entails the broker investing in a position alongside the client; and the ratio between the respective investments is expressed as a ratio – $100 of the broker’s money alongside $1 of the clients is expressed as a leverage ratio of 100:1. As a result, if the client invests $1, a movement of 1 pip that would be worth 1/100th of a cent is worth 1 cent if leveraged at 100:1. A $20 investment on a typical day where the movement is worth about 35 pips would result in a 7 cent profit or loss without leverage, $7 with (i.e. 35%!!).