Finance

What is Forex Trading and the Concept Behind Trading Currency Pairs

Written by shozich

Foreign exchange (Forex or FX) is an over-the-counter and global market where investors, traders, and institutions speculate on and exchange world currencies. Forex trading is done through the “interbank market,” which is an online channel to trade currencies 24/7.

It won’t be wrong to say that forex ranks among the largest financial markets. According to the Bank of International Settlement’s quarterly report, the worth of the global forex market is approximately $2.4 quadrillion or around $2409 trillion. In April 2019, the daily trading volume of the forex market was reported $.6 trillion.

First things first, before delving deeper into the concepts of foreign exchange, let’s start off with what the forex market is.

What is the Forex Market?

If you have ever travelled abroad, you must have made a foreign transaction. Take a trip to Japan, and you have to convert the currency into Yen. Based on the supply and demand of the currency, the forex exchange between the two currencies will determine how many yens you will get for the currency you have. You should know that the exchange rate fluctuates continuously.

Currencies are important because you need them to purchase goods and services both locally and abroad. You need to exchange international currencies for conducting trade and business. The unique aspect of the international market is that there isn’t any designated central marketplace for foreign exchange. Instead, currency trading is done over-the-counter, and all transactions occur through computer networks globally.

The major financial centres are New York, London, Tokyo, Hong Kong, Zurich, Frankfurt, Singapore, Sydney, and Paris. Put simply, you can trade across different time zones, which means when the trading day ends in New York, it starts off in Hong Kong and Tokyo. Thus, the forex market remains active 24 hours a day, and the prices keep on changing constantly.

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Key Differences Between Swapping Currencies Abroad And Forex Trading

Some most common differences between swapping different currencies abroad and trading in the forex market, which are:

  • The major difference is the convenience. As the forex market is a decentralised and electronic exchange, you can trade currencies from the comfort of your couch or from your office cabin.
  • The second one is efficiency. Forex trading is highly liquid, which promotes regular volatilities, tight spreads, and rock-bottom pricing.

Undoubtedly, participating in the forex market is the most efficient and easiest way to exchange currencies. You don’t need to wait for hours in the queue to meet a currency dealer or pay undue premiums. Rather, you just need good intellectual and computing power, a strong internet connection, and a forex broker to engage in the market.

What is a Currency Pair?

A currency pair is acutally the quotation of a pair of currencies, where one currency is quoted against the other. When you are getting started with forex trading, you must know the basics. The first listed currency in a currency pair is called the base, and the second one is called the quote, which works as the benchmark.

You should compare currency pairs against one another to understand how much the quote currency you need to buy one unit of the base currency. Commonly, a three-letter symbol is used to identify each currency. For example, NZD is used to represent New Zealand Dollar in the international market.

When buying a currency pair in the forex market, investors purchase the base currency and sell the quoted currency. On the other hand, the investors sell the base currency while receiving the quote currency when the currency pair is sold. In simpler words, investors are selling one currency to buy another when trading currencies.

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Three Major Categories of Currency Pairs

Currency pairs are usually categorised in the following:

The “Majors”

The “Crosses”
The “Exotics”

You must know that the major currency pairs will always include the US dollar. Crosses don’t include USD, and if they contain any major currencies, these are known as “minors.” However, exotic currency pairs have one major currency and the other currency from an emerging market (EM).

Factors Affecting Currency Pairs

As the forex market is the most volatile, several factors impact the currency pairs:

  • Federal Reserve Actions

  • Interest Rates

  • Inflation Rates

  • Country’s Current Account

  • Political Stability and Performance

  • Terms of Trade

  • Government Debts

  • Gross Domestic Product (GDP)

  • Other economic announcements

Minors and Exotics

Both minors and exotics are not associated with the USD. You will see that these currency pairs have a lower amount of liquidity and larger spreads as compared to majors.

Minor currencies, however, are paired with the USD. If the quote is paired with currencies other than USD, it is termed as a currency cross. The most common currency crosses include EUR, JPY, and GBP. However, the rates of currencies are devised universally, and the primary currency rate is always taken against the USD. However, the rate of the second currency is multiplied or divided against the USD.

More often, the base currency can also refer to the currency of the bank or the institutions- commonly their domestic currency. For instance, British-owned institutions may use GBP as the base currency while accounting because all the profits and losses will ultimately be converted into sterling at the end.

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Exotic currency pairs are those related to the emerging markets. For instance, USD/HKD.

Majors

These currency pairs are the most traded across the world. It won’t be wrong to say that major currency pairs made the biggest portion of the foreign exchange market, approximately 85% of it. As various currencies come and go, the amount of major currency pairs also changes. Major currency pairs have extremely high market liquidity, and the following are the seven major currency pairs:

  • EUR/USD

  • GBP/USD

  • NZD/USD

  • USD/JPY

  • USD/CHF

  • AUD/USD

  • USD/CAD

The last two currency pairs are termed commodity currencies due to the fact that both Australia and Canada are rich in commodities.

This was a quick introduction to forex market and currency pairs.

About Author:

Maryam Rafi has been working as a freelance content writer and have extensive experience in article and blog writing. She is a strong advocate of big dreams and believes in making them true. She works with B2B and B2C businesses for copywriting, article and blog writing services. She loves to write articles about marketing, business safety, entrepreneurship, fashion, health, health, fitness, and many more.

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