forex-basics

Forex Basics

In this article, let us learn Forex Basics, its definitions and elements and anything involved.

We will explore the different currencies and their relationships with one another.

After reading this article , you will hopefully be able to grasp the basic principles of trading Forex, while also understanding its movements and the forces behind them.

However, even if you are not trading days, you’d be able to take advantage of the Forex market.

You can participate in trading from wherever you are!

All these factors make the Forex market the best among the rest.

Even though the Forex market is enormous, the concepts related to the market are more straightforward and easy to understand.

As beginners, you must understand the principles and concepts of Forex trading before you begin your trading journey.

The Forex market isn’t as confusing as the stock market because you can choose from the eight major economies and decide what to trade and when to trade.

You decide your move, so there is nothing to worry about!

The eight countries that you’ll handle are the United States, Japan, Eurozone, Canada, Switzerland, New Zealand, Australia, and the United Kingdom.

These countries have the cosmopolitan financial industries when compared to other countries.

If you study these countries, you’d be able to enjoy enormous benefits of Forex trading.

Anyway, now, let’s explore the basics of Forex trading!

US Dollar (USD)

To this day, the United States dollar remains the world’s most important currency.

This is particularly true in Forex.

The strength of the US dollar has proven itself to be formidable, despite having gone through a lot of financial roadblocks instigated by local and global turmoil.

The strength of the currency can be attributed to the country’s continued economic strength.

The United States has the largest economy, and the country does possess an abundant and liquid capital.

Aside from its economy, the strength of the country’s currency can also be attributed to its role in the global stage and might of its political and military presence.

The movements of all other currencies still pivot around the market’s perception of the US dollar, making it the fulcrum of the Forex market.

The US dollar is the most liquid among the other currencies, making it the only option to become the world’s reserve currency.

Around 65 percent of the world’s reserves are in US dollars.

Due to this fact, central banks around the world now choose to hold a massive amount of this particular currency within their ledgers.

Investors and businesses also regard the US dollar as the go-to safe currency.

This has been proven during different global financial situations.

During the global credit crisis in 2009, which caused the Lehman Brothers and Bear Stearns to go bankrupt, the US dollar actually appreciated in value.

Investors who were fearful for the worst moved their assets to US government securities, which resulted in the currency’s value increase.

While most may not agree that treasury bonds are the safest location, what is important to note is that the US dollar is perceived as the safest investment in the world.

As of the moment, the US dollar remains at the top in the Forex markets.

Euro (EUR)

While being relatively new on the global financial scene, the euro is currently the second most important currency in the Forex market.

The currency was introduced in 1999 and officially entered circulation in 2002.

The euro was meant to centralize the currencies of the different European countries, which mostly had their own currencies.

Due to the proximity of the nations belonging to the European Union, a solution had to be made to eliminate unnecessary currency conversions.

Over the years, it has completely replaced other sovereign currencies, including most recently the French franc and the Deutsche mark.

The euro is currently valued higher than a US dollar, and it has been able to keep it that way since it was introduced.

The euro has also much appreciated in value by more than 70 percent since 2002.

Investors and traders who bet big on its rise certainly made a lot of profit during that time.

Over the years, a lot of confidence has also been put on the currency, making it a good alternative.

Similar to other currencies, the euro has had its own share of ups and downs, particularly during the global credit crisis in 2008.

The euro peaked at US$1.60 during that year.

The global credit crisis wreaked havoc on the European banking system.

The situation got worse, and the European Central Bank had to intervene.

Several members of the European Union were on the verge of bankruptcy.

Portugal, Ireland, Greece, and Spain all received financial support from the IMF and the European Union to avoid defaulting on their debt.

Japanese Yen (JPY)

The Japanese yen has been one of the most successful stories in modern foreign exchange.

Japan’s recovery after World War II saw it emerge as a formidable economic force on the world stage.

Since the yen’s introduction to the work market, it has grown by a staggering 400 percent against the US dollar.

The rise started with the initial economic boom in Japan and is continuing up to this day.

Japan is currently one of the world’s second-largest economies, and it was holding that position until China overtook it.

The growth of the Japanese yen has unfortunately halted by the early 1990s.

However, it has managed to stay at the same relative value.

Price inflation in the country has not been a problem in the country, partly thanks to its sophisticated financial system.

Japan currently has one of the largest debts in work, on a per-capita basis, but it continues to enjoy healthy demand for its currency.

The country continues to attract large investments from all over the world.

The performance of the Japanese yen and the country itself is quite impressive given that it does not have a lot of natural resources.

The country mostly gets its commodities and energy needs from other nations.

In the last decade, the value of the yen had slightly declined.

This was mainly caused by extremely low-interest rates in Japan, which some investors had taken full advantage of by taken out loans and making investments abroad.

The decline was halted when investors decided to let go of their short bets on the currency.

British Pound (GBP)

The British pound, or the pound sterling, is currently the fourth-most-traded currency.

Prior to the rise of the US Dollar, it was the strongest currency in the world.

The strength of the British pound can be attributed to the fact that London remains to be the preeminent currency trading center in the world.

Post-World War II, the British pound had gone through quite the fluctuations.

Most of the dips can be attributed to the country’s continually rising inflation and unemployment levels.

The country’s housing market is also nowhere near as robust as other countries.

The United Kingdom’s debt is also quite substantial, and its decision to print more money only made it worse.

Like other currencies, the British pound dropped significantly during the 2008 financial crisis.

Swiss Franc (CHF)

Switzerland is amongst the wealthiest countries in the world, and its economy is robust and has proven itself to be very stable.

Due to this fact, the Swiss franc has become the go-to currency for those looking for an excellent place to store their finances.

The economy’s stability is mostly thanks to the country’s trade surplus and its profitable exports.

This includes the export of highly-valuable jewelry such as expensive Swiss watches, tobacco products, chemicals, and manufacturing equipment.

Switzerland also mostly evaded the effects of the global credit crisis thanks to the Swiss National Bank’s decision to refrain from printing money.

Similar to the US dollar, the Swiss franc is a safe-haven currency.

Some would even argue that it performs better than the US dollar in this regard.

In fact, during times of global financial uncertainty, the value of the Swiss franc typically increases more than the other “safe” currencies.

As for its movement in the Forex market, the Swiss franc closely mirrors the movement of the euro.

This is mostly due to the close relationship with the Swiss and the Eurozone economies.

However, the currency’s value does deviate in times of political strife, thanks mainly to the country’s neutrality in global political issues.

Australian Dollar (AUD)

While it might not sound correct, the Australian dollar is actually one of the strongest commodity currencies in the market.

Its movement is closely tied to the movement of global commodity prices.

This is mainly since the country is one of the world’s largest producers of iron ore, coal, and other precious metals.

The country’s economy has so far taken advantage of China’s growing demand for energy and basic commodities.

Thanks to this, the country’s economy was really damaged by the recent global financial crisis.

Due to its close trade relationship with Asian countries, especially China, the Australian dollar’s movement does somewhat mirror that of the Chinese yuan.

In fact, some investors even treat the currency as a good proxy for the Chinese yuan.

Canadian Dollar (CAD)

The Canadian dollar is another commodity currency that is closely related to global commodity prices.

The country is a large producer of energy commodities such as petroleum, timber, and coal. It also exports a number of agricultural products to different parts of the world.

The Canadian dollar took advantage of the commodities boom in the mid-2000s and gained in 2010 where its value equaled that of the US dollar.

This was the very first time that the Canadian dollar reached parity with the US dollar in over 30 years.

Canada’s economy is greatly dependent on that of the United States.

Canada produces oil, electricity, and natural gas for the United States, which purchases around 75 percent of what the country produces.

When the United States experiences a downtrend in its economy, the Canadian dollar swiftly follows.

Other Currencies

There are currently around 180 legal currencies that are circulating throughout the world.

Amongst those currencies, only a handful are actively traded on the Forex market.

Most Forex brokers trade between 40 to 70 currency pairs, with some trading more than others.

Aside from the currencies mentioned above, there are a few currencies that have become recently significant.

This includes the New Zealand dollar, which is closely influenced by the movement of the Australian dollar.

The New Zealand dollar is also greatly reliant on the prices of global commodities.

The country is a large producer of agricultural products and dairy-based items.

The Chinese Yuan has also recently gained prominence, thanks to the rapid growth of the country’s economy.

It is arguably a currency that investors should look out for given its sudden emergence into the world stage.

China has the second largest economy in the world, and it is one of the biggest international traders out there.

The Chinese Yuan is pinned to the US dollar.

Apart from the major currencies mentioned above and the recent ones that have gained prominence, all of the other currencies are considered to be exotic currencies.

These currencies are also sometimes referred to as emerging market currencies; mostly due to their association with their respective country’s emerging economies.

These economies tend to have large fluctuations in the market, mostly due to high inflation and significant political and economic changes.

In some cases, some of these currencies can rise to unprecedented levels when times are good.

However, these are also the currencies that drop the most during times of crisis.

Some of the more popular exotic currencies that are traded in the Forex market include the Korean won (KRW), Turkish lira (TRY), the Russian ruble (RUB), the Indian rupee (INR), the Brazilian real (BRL) and the South African Rand (ZAR).

Along with seven other exotic currencies, these emerging currencies
account for a combined 9 percent overall trade volume in the Forex market.

Currency Pairs

Among the 160 different currencies circulating in different parts of the world,
there are only handfuls that are actively exchanged in the Forex market.

Most of them are only exchanged in the territories where they are used.

The current Forex market actively trades in only around 17 currencies based on their liquidity and the number of exchanges made between those currencies.

These so-called major currencies account for over 90 percent of all the money exchanged in the foreign currency exchange market.

Similar to company stocks in the stock market, currencies are assigned three letter abbreviations, set by the International Standards Organization.

This greatly simplifies the quoting and trading of these currencies in the world market.

When trading these currencies, the quote for these trades is always shown in pairs.

Each currency fluctuates relative to other currencies, which is why they are traded in pairs.

Out of the active major currencies, there are hundreds of potential currency combinations.

However, there are about 100 pairs that are commonly traded, with around 50 pairs actively being used by international Forex brokers.

In Forex trading, exotic currencies are generally paired with major currencies.

It is doubtful that a non-major currency will be paired with another non-major
currency.

As an example, it would be challenging to find an exchange that trades the Uruguay Peso and the Iraqi dinar.

However, finding an exchange that trades those currencies with the US dollar is relatively easy.

Some companies and individuals do exotic trade pairs with another, but their volume merely is just too small for international brokers.

Currency Quotations

The International Organization for Standardization submitted ISO 4217 in 1978. The standard assigned three-letter codes to represent individual currencies to be used in any application for trading, banking, and commerce.

It was also agreed upon that the three-letter alphabetic codes for International Standard ISO 4217 would be used in international trading.

The list of codes is also frequently updated, as new currencies emerge and older ones are discontinued.

When it comes to Forex trading, currencies always come in pairs.

As an example, a trade made with the US dollar versus the euro would look like this (USD/EUR).

The US dollar versus the Canadian dollar would look like this (USD/CAD). It goes without saying that a currency can never be traded without itself.

The first currency indicated in the quotation is called the base currency, while the second one is referred to as the counter currency.

A numerical value is assigned to the currency pair that may be up to 4 decimal places.

The last decimal place is referred to as a “pip.”

The value assigned to currency pairs is the amount of the counter currency required to buy one unit of the base currency.

As an example, if the USD/CAD is quoted at 1.32, it means that it would currently require 1.32 Canadian dollars to buy one single US dollar.

On trading platforms, these values would fluctuate in real-time as the value of each currency varies depending on the market.

In live trading, currency pairs are often quoted with two separate values called the bid-ask spreads.

The first value indicates the amount of the counter currency you will get in exchange for one unit of the base currency, the bidding price.

The second value indicates the amount of the counter currency needed to get one unit of the base currency; the asking price.

Spread amounts may vary with different brokers, and there are also different types of spreads that are used in Forex trading.

As for the nature of the Forex market, traders can make money when a pair’s value rises and falls.

This is mainly because trading in Forex involved the buying of one currency, while also selling another currency at the same time.

There are also no restrictions on short selling.

Movement

I have covered all the important currencies that you must know if you want to trade Forex.

Thus, let’s learn the movement in Forex.

Forex trade movements are mostly dependent on people’s expectations of the future values of different currencies.

Expectations are also reliant on many factors.

Also, different market participants have different goals in investing money into the Forex market.

Some companies trade currencies to protect their business’ capital. Some fundamental traders focus on economic and political factors that affect the economies of the different countries involved.

Meanwhile, technical traders look at patterns, trends, and other indicators.

Various traders place different weights on different information, such as local laws, economic situations, interest rates, disasters, and human-made events.

The participants in the foreign exchange market include central banks, large conglomerates, financial institutions, and individual Forex traders.

However, the influencers of these participant’s expectations include natural events, geopolitical changes, economic news, local laws, and interest rates.

Making Money

Making money in the Forex Market is pretty straightforward. It’s all a matter of buying and selling currencies at the right time.

The underlying principle of a trade is very similar to other financial markets, so those with prior experience in trading on the stock market should be able to grasp the concept quickly.

The name of the game entails the exchange of one currency for another with the expectation that the value of one currency will differ in comparison to its currency pair.

To make money, the value of the currency that was bought should increase in value compared to the currency that was sold.

The principle can be applied whether the value of the base currency goes up or goes down.

Betting that the value of the base currency will go up is called “going long.”

This basically means that you are buying the base currency and selling the quote currency.

When the value of the base currency increases, traders will then sell it back in the market at a higher price.

The difference in the values is what you take home with you as your earnings for that trade.

Alternatively, if you want to bet on the base currency going down, you want to sell or “go short.” This basically means that you are selling the base currency and buying the quote currency.

You make money by then buying back the base currency using the quote currency at a lower price than when you sold it.

Brokers often make these trades relatively easily by allowing you to simply click on a “Buy” or “Sell” button depending on what you expect the market to do.

In simple words, you’ll be trading currencies instead of foods and other products when you are in the Forex market.

Published by

MagForex has been actively trading currencies since 2008 and up until today, he is still very passionate about it.