Understanding Forex

The foreign exchange market is the world’s largest capital market with liquidity that provides the exchange of more than 5-trillion-dollar worth of currency per day. While the markets are open 24-hours a day, 6-days per week, there are many time where liquidity is stronger than others. The markets theoretically open in Asian when Australia kicks starts the day and closes in New York late in the evening. It’s during the European trading session that the liquidity of foreign exchange is most active, and provides the best prices for traders who are looking to transact.

What is a Currency Pair?

The security that is traded in the forex market is a currency pair. The price is referred to as the exchange rate and it represents the price at which one currency can be exchanged for another. Each currency pair has its own base currency and counter currency. The base currency tells the trader the denomination of the units. Additionally, there is a pecking order of currencies, which determines which is the base currency and which is the counter currency.

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Major Currency’s

A major currency pair is one that at the minimum contains the U.S. dollar as one of the two currencies in the pair. There are 7 major currency pairs which include the Euro, the Yen, the British Pound, the Swiss Franc, the Australian dollar and the Canadian dollar. Major currency pair have the most liquidity and are traded actively around the clock.

Bids and Offers

There are some other little trading tips in the forex market that are key to understand. For example, when you buy a currency pair you purchase the security at the offer price. The offer is where a market maker is willing to sell the currency pair to you. The offer is the right side of the currency pair, while the bid side is the left side of the currency pair. If you are looking to sell the currency pair, you would do it where a market maker is willing to purchase the currency pair.

For example, if you are looking to purchase the EUR/USD currency pair, and you see a quote of 1.3501/03, you could immediately purchase the exchange rate at the price of 1.3503. You should understand that this transaction means that you are purchasing the Euro and selling the U.S. dollar at the designated exchange rate. The exchange rate 1.3503 means that you need 1.3503 dollars to purchase 1 Euro. The traders that purchases this currency pair benefits if the exchange rate increases.

Basic Currency Transactions

The most basic currency transaction is a spot transaction. This type of currency trade is based on the idea that the currency funds will settle within two business days. This means that if you are trading in the spot market, your dealer will expect you to deliver the currency you are short to a designated account. There are some currencies that are delivered tom/next. That means that you are expected to deliver the physical currency the next business day. If on the other hand you plan on holding the currency for a while, you would transact in the futures market and deliver your physical current as some date in the future.

A more popular style of currency trading is available as a non-deliverable forward transaction. When you are trading this type of currency transaction, you are not expected to deliver a physical currency and you are only responsible for the difference once the trade is offset. So if you experience a loss, you are responsible for the difference. Trading currencies provides an opportunity to transact in the most liquid capital market the world currently offers.

Author: Jeremy Biberdorf

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