The forex market is the largest financial market with daily transactions amounting to more than $5 trillion – it has more transactions than the ones on the futures and equity markets combined together.
1. How does forex trading work?
In the forex market one currency is exchanged for another. The most important thing when trading on the forex market is the exchange rate. It changes constantly, sometimes a few times per second and is usually quoted in currency pairs. For example, if EUR/USD = 1.1385, this means that if you sell EUR 1 you will receive USD 1.1385. In the same example the euro is the base currency and the dollar – the quoted currency.
The forex market is open 24 hours, 5 days a the week, and is moving to different financial centers in the world. The market first opens in Sydney, then moves to Tokyo, London, Frankfurt and finally in New York before opening again in Sydney.
2. Short and long positions
First, you should decide if you want to buy or sell. To buy a currency pair means to buy the base currency and sell the quoted currency. In this situation you are counting that the base currency will rise and you will be able to sell it for more. This means that you are going long. On the other hand, when selling a currency pair you are selling the base currency and buying the quoted currency. In this situation you are counting on the fact that the price of the base currency will fall and you will be able to buy it back at a lower price. This is called going short.
3. The bid and ask price
All currency pairs are quoted with bid and ask price. The bid price is the best price at which you could sell to the market. That is to say, if you want to sell an asset on the market, the bid price is the price at which your broker is willing to buy the base currency in exchange for the quoted currency. While the ask price is the price at which your broker is willing to sell the base currency in exchange for the quoted currency. In other words, this is the best available price at which you could buy from the market. And the difference between the bid and ask price is called spread.
4. Major and minor currency pairs
Currency pairs that contain the dollar are the most liquid and widely traded ones. They are called majors and include: EUR/USD, USD/JPY, GBP/USD, USD/CHF, USD/CAD, AUD/USD и NZD/USD. Currency pairs, which do not contain the dollar are called cross. The major crosses are also known as minor currency pairs. For example, cross currency pairs that contain the euro include: EUR/CHF, EUR/GBP, EUR/CAD, EUR/AUD, EUR/NZD and others. Likewise there are crosses with pound, yen and with other currencies. There are also exotic currency pairs. They are made up of one major currency paired with the currency of an emerging economy such as Brazil, Mexico or Hungary. However the transaction costs associated with trading these pairs are bigger so they are not as widely traded. Example of exotic currency pairs include the: USD/HKD, USD/ZAR, USD/MXN, USD/DKK. USD/RUB, USD/PLN and others.