Foreign exchange, commonly known as ‘Forex’ or ‘FX’, is the exchange of one currency for another at an agreed exchange price on the over-the-counter (OTC) market. Forex is the world’s most traded market, with an average turnover in excess of US$5.3 trillion per day.
Essentially, forex trading is the act of simultaneously buying one currency while selling another, primarily for the purpose of speculation. Currency values rise (appreciate) and fall (depreciate) against each other due to a number of factors including economics and geopolitics. The common goal of forex traders is to profit from these changes in the value of one currency against another by actively speculating on which way forex prices are likely to turn in the future.
Unlike most financial markets, the OTC (over-the-counter) forex market has no physical location or central exchange and trades 24-hours a day through a global network of businesses, banks and individuals. This means that currency prices are constantly fluctuating in value against each other, offering multiple trading opportunities.
24-Hour Forex Trading
One of the key elements behind forex’s popularity is the fact that forex markets are open 24-hours a day from Sunday evening through to Friday night. Trading follows the clock, opening on Monday morning in Wellington, New Zealand, progressing to Asian trade spearheaded out of Tokyo and Singapore, before moving to London and closing on Friday evening in New York.
The fact that prices are available to trade 24 hours a day helps to ensure that price gapping (when a price jumps from one level to the next without trading in between) is less and ensures that traders can take a position whenever they want, regardless of time, though in truth there are certain ‘lull’ times when volumes are below their daily average which can widen market spreads.
Foreign exchange is a leveraged (or margined) product, which means that you are only required to deposit a small percentage of the full value of your position to place a forex trade. This means that the potential for profit, or loss, from an initial capital outlay is significantly higher than in traditional trading. Find out more about risk management.
All forex is quoted in terms of one currency versus another. Each currency pair has a ‘base’ currency and a ‘counter’ currency. The base currency is the currency on the left of the currency pair and the counter currency is on the right.
For example, in EUR/USD, EUR is the ‘base’ currency and USD the ‘counter’ currency. Forex price movements are triggered by currencies either appreciating in value (strengthening) or depreciating in value (weakening). If the price of EUR/USD for example was to fall, this would indicate that the counter currency (US dollars) was appreciating, whilst the base currency (Euros) was depreciating.
When trading forex prices, you would buy a currency pair if you believed that the base currency will strengthen against the counter currency. Alternatively, you would sell a currency pair if you believed that the base currency will weaken in value against the counter currency. Some examples of major currency pairs are:
- EUR/USD (The value of 1 EUR expressed in US dollars)
- USD/CHF (The value of 1 USD expressed in Swiss francs)
Pips (Percentage in Points)
Pip stands for Percentage in Points. Most of our currency pairs are quoted to 5 decimal places with the change from the 4th decimal place (0.0001) in price commonly referred to as a ‘pip’. For example, if the price of the EUR/USD forex pair moved from 1.13500 to 1.13520, it is said to have climbed by 12 ‘pips’ (92-80=12).
The difference in the BID/ASK of the currency pairs is referred to as the ‘spread’. An example would be EUR/USD dealing at 1.13800/1.13803 (in this case the spread is 0.3 pips or 0.00003). The exceptions to this are the JPY pairs which are quoted to just 2 decimal places. A USD/JPY price of 97.41/97.44 displays a 3 pip ‘spread’.
What affects forex prices?
Forex prices are influenced by a multitude of different factors, from international trade or investment flows to economic or political conditions. This is what makes trading forex so interesting and exciting. High market liquidity means that prices can change rapidly in response to news and short-term events, creating multiple trading opportunities for retail forex traders.
Some of the key factors that influence forex prices are:
- Political and economic stability
- Monetary Policy
- Currency intervention
- Natural disasters (earthquakes, tsunamis etc)