Every country has its own currency and the strength of that currency is based on that country’s economy. When traveling to another country, you have probably noticed the little booths set up in the airports that specialize in currency exchange. They usually have a digital screen that reads the different exchange rates.
Let’s say that you are an American visiting Germany, so essentially, you are exchanging American dollars to Euros. To be simple, you trade in $100 and you get back 90.29 Euros. When you leave Germany to go back to the United States, you exchange your remaining Euros back into dollars, but have noticed that the exchange rate has changed.
These exchange rates going up and down is the forex market, and by exchanging one currency for another, you’re participating in the largest financial market in the world; the forex market.
Forex, also known as “FX”, is short for foreign exchange. 5 Trillion is the amount of volume traded daily. It is massive compared to other markets like the New York Stock Exchange (NYSE) that trades 22.4 Billion a day. However, retail traders like us, trade 1.5 Trillion on a daily basis.
Forex can be somewhat confusing to some people because you aren’t actually trading anything physical. The best way to describe forex trading is to think of it as buying a piece of a country’s economy. Essentially, money is the answer to what is traded in forex.
Let’s say the United States unemployment rates were at a steady decline and oil production was increasing, one might want to invest in the US dollar as it would be getting stronger at that point.
The exchange rate of one country’s currency to another country’s currency is a direct comparison of the two different countries economies. The currencies are always represented with three different letters. The first two letters represent the country and the third letter represents the currency. For instance, USD would represent the United States dollar. Below is a list of the major currency pairs:
|EUR||Euro Zone Members||Euro||"Fiber"|
Currency trading is usually always done through a broker or dealer, and is always traded in pairs. It is a constant push/pull concept of buying one currency and selling of another. The exchange rates are constantly changing on a basis regarding which currency is stronger.
A currency pair could look something like this (USD/JPY), which would stand for US dollar and Japanese yen.
All major currency pairs contain the USD on one side of the spectrum and are traded the most among retail forex traders. They are also the most liquid.
Cross-currency pairs, also known as “crosses”, are pairs that don’t contain the USD such as (EUR/JPY). These crosses or minor currency pairs are mostly derived from 3 major currencies; the EUR, JPY, and GBP.
The forex market is entirely run electronically, so it is considered an “interbank” or “OTC” (Over-the-Counter) market. It runs continuously over a 24-hour period through a network of banks. There is no central exchange or physical location as there are in the NYSE.
Large numbers of organizations and individuals can trade the forex spot market anywhere in the world. It is vital to know what different brokers offer to determine which one to trade with.
An astounding 84.9% of all transactions are comprised of the USD. It is of the utmost important to pay attention to it. Every central bank, business, and investor own the U.S. Dollar, and according to the International Monetary Fund (IMF), it makes up 62% of the world's official foreign exchange reserves.
The Euro is second at 31.9%, followed by the yen at 19% of all transactions.
Reasons the US Dollar play a central role in the forex market:
Many cross-border transactions are done with the US dollar. Oil is priced in the US dollar, so if a country wants to buy oil from Saudi Arabia, it must first exchange their country's currency into the US dollar.