What is FX?
Trading currencies in pairs
The FX elevators
WHAT IS FOREX
You’ve come to our site because you’re interested in trading forex. But what exactly is forex?
Forex, or FX as the professionals say, stands for foreign exchange. It’s the buying and selling of currencies.
You may have participated in the forex market already. If you ever went on a trip abroad, you probably had to go to an exchange booth and change your money into the money of the country that you were visiting.
When you came back, you changed any money you had left over back into your home currency. You might have noticed that the price you got when you bought your money back was different from the price you got when you first exchanged your money, and you got more or less money back than you changed originally. That’s the forex market in action.
The idea of buying a currency is a bit counter-intuitive. Everyone knows that if you go to the store, you can use money to buy things -- eggs, for example. So we’re used to thinking of the price of eggs in terms of money – maybe a dozen eggs cost 4 dollars. But we don’t usually think of the price of money, although you can look at it that way, too. In this case, a dollar costs three eggs.
In theory. if you buy a dozen eggs for 4 dollars and the price of eggs goes up, you could later sell your eggs at a profit. It’s the same with currencies. You can buy euros and if the
TRADING CURRENCIES IN PAIRS
In the forex market, you’re not buying currencies with eggs, though. Naturally, you buy currencies with…other currencies! You might buy euros with dollars. Or buy dollars with Japanese yen. Or buy Japanese yen with British pounds.
Notice though that since you’re buying money with money, every trade involves two different currencies. When you trade forex, you’re automatically buying one currency and selling another. Buying euros with dollars means selling dollars to buy euros. Buying dollars with yen means selling yen to buy dollars. You’re speculating that the price of the currency you’re buying will go up relative to the price of the currency you’re selling.
In forex, you always have to trade a currency pair: one currency that you’re buying and one currency that you’re selling.
WHICH CURRENCIES TRADE
There are around 160 currencies in the world today, but not all of them are actively traded. The Continuous Linked Settlement (CLS) Bank, which is at the heart of the foreign exchange market, settles around half the volume in the foreign exchange market every day but only deals with 18 currencies.
As you can see from the graph, the dollar – the red section in the pie - dominates dealing. It accounts for some 43% of total turnover in the spot market, the market for money for immediate delivery. After that, activity falls off sharply. The euro, the blue section, is next but with a “market share” of only 15%. The Japanese yen, the green slice of the pie, has 10% and the British pound 5%. After that comes the Chinese yuan, Australian dollar, Canadian dollar, and the Swiss franc.
The eight currencies shown here account for 86% of the total turnover in the market, and even at that, the 4% figure for the yuan is probably artificial - it isn’t a freely traded currency. So the actual market share of the remaining seven is a bit higher.
Secondly, most currencies are traded against the dollar. For example, you can certainly find a broker who’s willing to quote you a price to buy British pounds against the dollar or to buy Canadian dollars against the US dollar, but it’s possible that a broker might not quote a price if you wanted to buy British pounds against Canadian dollars. In that case you could buy British pounds against US dollars, then sell Canadian dollars against US dollars. This is certainly the case for more exotic currencies such as the Hungarian forint or the Thai baht. If you’re in Hungary and you want to go on holiday to Thailand, you’re probably going to have to change your forints into dollars and then your
THE FX ELEVATORS
How do you know if your currency is going up or down? Well, frankly, it doesn’t really matter to you. All that matters is whether the one you’ve bought goes up relative to the one you’ve sold
You should think of the various currencies like a bank ofelevators. Some elevators are going up and some are going down. Two of them can go up, but if Elevator A is going up faster than Elevator B, then Elevator B is falling relative to Elevator A. Their movement is all relative.
Your aim in trading forex is to buy a currency that’s going up relative to the one that you’ve sold. It doesn’t matter if they both go up or down relative to another currency. Then when you close out your trade – when you sell the currency you bought and buy back the currency you started out with, the one you sold – you’ll have more of the currency that you started out with. That’s your profit.
Now, you may ask…why does one currency go up or why does another currency go down? Well, that’s a pretty complicated question, so let’s save it for later.
SUMMARY
Forex trading involves buying and selling the currencies of different countries against each other. In forex trading, you buy one currency and sell another in the expectation that the one you buy will appreciate relative to the one you’ve sold. That’s how you make a profit.
