What is Foreign Exchange/ Currency Trading ?
Foreign exchange (Forex or FX) trading, also known as currency trading, is the global
marketplace for buying, selling, exchanging, and speculating on currencies. It is one of the
largest financial markets in the world, where trillions of dollars worth of currencies are
traded daily. Here's a breakdown of how it works:
Key Concepts:
1. Currency Pairs:
o In Forex trading, currencies are traded in pairs (e.g., EUR/USD, GBP/JPY). The
value of one currency is determined relative to another.
o The first currency in the pair is called the base currency, and the second is the
quote currency. For example, in the pair EUR/USD, EUR is the base currency,
and USD is the quote currency.
2. Exchange Rate:
o This is the rate at which one currency can be exchanged for another. It
reflects the value of one currency relative to another.
3. Bid/Ask Price:
o The bid price is the price at which the market is willing to buy a currency.
o The ask price is the price at which the market is willing to sell a currency.
o The difference between the bid and ask price is called the spread, which
represents the cost of the trade.
4. Leverage:
o Forex traders often use leverage, which allows them to control a large
position with a relatively small amount of capital. While leverage can amplify
profits, it also increases potential losses.
5. Spot and Forward Markets:
o The spot market is for immediate (or nearly immediate) currency
transactions.
o The forward market is for contracts that settle at a future date, at a
predetermined rate.
6. Speculation and Hedging:
o Many participants in the Forex market trade for speculative reasons, aiming
to profit from currency price movements.
o Others, like businesses or governments, use the market to hedge against
currency risk.
Why Trade Forex?
• Liquidity: Forex is a highly liquid market, meaning it is easy to buy or sell currencies
without affecting the market price significantly.
• 24-hour Market: Since Forex is a global market, it operates 24 hours a day, five days a
week, across various time zones.
• Leverage: Traders can control large positions with small investments, allowing for
potentially high returns, but with high risks.
What are currency pairs in forex market ?
In the Forex market, currencies are traded in pairs, known as currency pairs. A currency pair
consists of two currencies, where one currency's value is quoted against another. Each pair
represents the exchange rate between the two currencies, with one currency being the base
currency and the other being the quote currency.
Structure of a Currency Pair:
• Base Currency: The first currency in the pair (on the left).
• Quote Currency: The second currency in the pair (on the right).
For example, in the currency pair EUR/USD:
• EUR is the base currency (Euro).
• USD is the quote currency (U.S. Dollar).
If EUR/USD = 1.20, this means 1 Euro is equal to 1.20 U.S. Dollars. If you want to buy 1 Euro,
it will cost you 1.20 USD.
Types of Currency Pairs:
1. Major Currency Pairs: These are the most traded pairs, involving the U.S. dollar and
other major currencies. They are highly liquid and have low spreads. Examples
include:
o EUR/USD (Euro/US Dollar)
o GBP/USD (British Pound/US Dollar)
o USD/JPY (US Dollar/Japanese Yen)
o USD/CHF (US Dollar/Swiss Franc)
2. Minor Currency Pairs (Cross-Currency Pairs): These do not include the U.S. dollar but
involve other major currencies. They are also liquid but may have slightly higher
spreads than major pairs. Examples include:
o EUR/GBP (Euro/British Pound)
o AUD/JPY (Australian Dollar/Japanese Yen)
o GBP/JPY (British Pound/Japanese Yen)
3. Exotic Currency Pairs: These pairs involve one major currency and one currency from
a smaller or emerging economy. They are less liquid and tend to have higher spreads
due to lower trading volumes. Examples include:
o USD/TRY (US Dollar/Turkish Lira)
o EUR/ZAR (Euro/South African Rand)
o GBP/MXN (British Pound/Mexican Peso)
Understanding Currency Pair Pricing:
The price of a currency pair indicates how much of the quote currency is required to buy one
unit of the base currency. For example:
• If EUR/USD = 1.20, it means 1 Euro is worth 1.20 U.S. Dollars.
• If USD/JPY = 110, it means 1 U.S. Dollar is worth 110 Japanese Yen.
When trading a currency pair:
• Buying the pair means you are buying the base currency and selling the quote
currency.
• Selling the pair means you are selling the base currency and buying the quote
currency.
