The Forex Market

Sometimes referred to as FX or forex, the Foreign Exchange Market is undoubtedly the largest, most liquid and transparent financial market in the world today. The average daily turnover comfortably exceeds US$3.2 trillion. The average daily turnover of all US equity markets combined barely clocks 3% of what is traded in the forex market. One unique feature of the FX market is that profitability is not dependent on the whether the market rises or not. The cyclical changes that affect the equity markets are meaningless in an FX market. Profitability in the FX market depends on the ability to accurately predict shifts in relative values of two chosen currencies. Since the exchange rates are constantly fluctuating, the forex market offers a continuous opportunity for making profits.

Basic Concepts

Foreign exchange simply means trading one currency for the other. FX transactions typically involve one party buying a certain quantity of one foreign currency in exchange of a contractual quantity of another currency. In simple terms, currencies are traded in pairs and to make a profit, investors purchase the currency that is predicted to strengthen and then sell the other currency. For example if you predict that the USD will strengthen against the Euro (EUR), then your trading pair will be EUR/USD. While trading you will buy the USD and sell the Euro. Due to the constant fluctuations in the exchange rates, you can buy and sell in a bullish or bearish market and still have equal chances of netting a handsome profit.

Who Trades in the FX Market?

Forex traders can be categorized into two groups. These are the hedgers and the speculators. The hedging category includes governments, companies in export and import business and some independent investors who are exposed to foreign exchange. In this case, the bottom line is influenced by the relative movements between the domestic and the foreign currency. While it is arguable that hedgers form the core of foreign exchange trading, in reality they only occupy 5% of the actual FX market. Speculators create artificial rate exposure so as to make profits from the variations of the value of currencies. This group includes banks, corporations, individual currency speculators and a host of other financial institutions.

What are Currency Pairs?

FX trading can only be done in currency pairs. Each currency is always represented by a unique three letter code. The United States dollar is recognized by the code USD; European currency-EUR; Japanese Yen-JPY; the Swiss Franc-CHF; the Canadian Dollar-AUD; and the British Pound/Sterling-GBP. These are the world’s major currencies hence the reference-majors. Currencies can only be traded in pairs and is displayed as GBP/USD, JPY/EUR etc. The first currency is the primary/base/leading currency while the second currency is the secondary currency. Thus, the GBP/USD is the “currency pair”. This pairing is then followed by a five digit number decimated after the digit as in 1.3400. This number represents the ratio of the first currency against the other and it simply shows the quantity of the secondary currency that an investor needs in order to buy a single unit of the primary or base currency. In the GBP/USD 1.3400 case, one requires 1 US Dollar and 34 cents to exchange for 1 Sterling Pound.