Forex, Foreign Exchange or FX are all terms used to refer to Forex trading. But precisely what is forex trading? Simply put, it is the exchange of currencies, where a person through speculation buys a particular currency and simultaneously sells another at an agreed upon exchange value price. It works on the premise that the value of different currencies varies from time to time due to business environmental factors like; politics, monetary policies, natural disasters, currency intervention, as well as technological or economic factors.
The Forex traders try to profit from the price differences in these currencies by speculating how the forex prices might turn. Consequently, the dealer buys the currencies at marginally low prices with the intention of selling them the moment their prices appreciate. FX trading takes place over-the-counter and boasts of an estimated daily turnover of over five trillion US dollars, making it the most traded financial market globally.
A distinctive feature of the Foreign Exchange trading is that it does not have a physical location or a centralised exchange position. Nonetheless, the trading takes place for 24 hours a day, 5 days a week, through a well-synchronised network of financial institutions, businesses and individuals. A person can trade in Forex either directly over the Internet, or indirectly by using intermediaries like banks, brokers and dealers.
In Forex, the trading takes place in pairs and involves value comparison of the base currency and the counter currency. For instance, a person is likely to come across quotes like USD/JPY, EUR/AUD, EUR/USD and so on. The quotes depict the value of the base currency against the counter currency, where the left currency is the base and the one to the right is the counter currency. Forex traders purchase currency pairs whose base currency value is likely to appreciate against the counter currency. Likewise, they dispose of those whose base value they believe will weaken. Most Forex traders prefer trading with the most common and most liquid currency pairs like the US Dollar, Euro, the British Pound, the Japanese Yen, the Australian Dollar, the Canadian Dollar and the Swiss Franc.
Common Terms in Forex Trading
When trading in FX, a person is likely to encounter words like Pips and Spread. Essentially, Pips is an acronym for Percentage on Points referring to a currency change from the fourth decimal place. To make it clearer, say the price of the Euro/USD currency pair shifts from 1.1216 to 1.1226, it climbs by 10 ‘pips’ or 0.0010, obtained by subtracting 1.1216 from 1.1226. The spread, on the other hand, refers to the variance of the currency pair’s BID or ASK price. If in the above example, the Euro/USD dealt at 1.1216 /1.1222, then the spread will be 0.0006 or 0.6 pips.