Now we’re on to my favorite subject, the Foreign Exchange Market. Most traders refer to this market as the currency market or the forex market. We’ll use all three terms.
The forex market is quickly becoming favorite market for traders. There are no company financial statements to review, virtually no commissions and practically 24/7 trading. If you’ve traveled outside of the country for a study abroad you had to exchange your dollars for the local currency. That was a foreign exchange transaction.
Everyday the foreign exchange market trades trillions of dollars. Banks, businesses and individuals all trade together. If you’ve started to search for a few stocks to invest in then you already realize how many choices there are out there. The good news about forex is that there’s only 6 major currency pairs to trade.
The Basics of the Exchange
When you go to your local mall, you exchange cash for the latest clothes, right? The currency market is very similar, except with foreign exchange you exchange one currency for another.
The EUR/USD pair is the most widely traded pair. It is the EURO and the US Dollar. When I traveled to Spain I paid $1.32 to get 1 Euro. That was my exchange rate. The EUR/USD is quoted the same way, Dollars per Euro.
The current exchange rate is about the same, $1.32. There are many pairs to trade. If you are interested in Japan you can trade the USD/YEN. That is quoted in Yen per Dollar. There is a pair for every major currency in the world. The most popular pairs have USD or EUR since those countries currently have the most influence on the world economy.
Economic Analysis for Forex
When a government manages its finances properly, that’s a good thing. When they make products that the world wants, that’s a good thing. Good economic events make a country’s currency stronger, and bad economic events make their currency weaker.
It’s All Relative
Mark and Adam both scored well on the last history exam. Mark made a 90. That’s pretty good, right? But Adam made a 92. That’s better. Adam’s grade is the stronger one. If Adam and Mark were a currency pair, ADA/MAR, you would buy, or long, it. Why? Well ADA has more value than MAR. ADA is better in relation to MAR.
Let’s say that Mark studies really hard with his new hot tutor and on the next test he makes a 90, again. But this time Adam slacked off and only made an 86. So now Adam has less value and you want to sell. So you sell, or short, ADA/MAR.
You always make a decision to buy or sell the first currency pair, in relation to to other. When you buy EUR/USD you are buying Euro in exchange for US Dollars. When you sell EUR/USD, you are selling Euro in exchange for US Dollars.
If you are a little confused but interested in the forex markets then you should check out BabyPips.com. It’s a great site with lessons on Forex. I started there as well. Then if you’re ready to have a test run, open a demo account with our friends at Zecco. It is completely free and they have great information and support on their site as well.
Trading foreign exchange on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to trade foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite. The possibility exists that you could sustain a loss of some or all of your initial investment and therefore you should not invest money that you cannot afford to lose. You should be aware of all the risks associated with foreign exchange trading, and seek advice from an independent financial advisor if you have any doubts.