Basics of the Foreign Exchange Market

                                                                                         

Foreign exchange market operates by trading one
type of currency against another. Unlike other
financial markets, the market has no physical
location and no central exchange. It operates
through a global network of banks, financial
institutions, and individuals. The forex market
is emerging as the world's largest financial
market, operating round the clock with enormous
amounts of money traded on a daily basis.

Another major difference between forex market and
other financial market is that in forex,
investors can respond to currency fluctuations
caused by economic, political and social events
immediately, without waiting for the exchanges to
open. Modern news services, smart online charting
services, electronic forex trading platforms,
signal services exploded the forex market and
opened it for even small and medium traders and
investors.

In the foreign exchange market 6 major currency
pairs are traded the most, which accounts for
almost 90% of the daily trading activity. They
include:

1. EUR/USD = Euro versus U.S. Dollar
2. JPY/USD = Japanese Yen versus U.S. Dollar
3. USD/CHF = U.S. Dollar versus Swiss Franc
4. AUD/USD = Australian Dollar versus U.S. Dollar
5. GBP/USD = British Pound versus U.S. Dollar
6. USD/CAD = U.S. Dollar versus Canadian Dollar

When reading these forex quotes we have to look
at the bid price which is the highest price for
buying versus the ask price which is the lowest
price to sell. The first currency of the pair (
EUR/USD) is known as the base currency and has
the value of 1. If the bid of the Euro versus U.S.
Dollar is 1.2811, it means that for buying one
Euro we have to pay $1.2811.

When the bid and ask prices moves in an uptrend,
it suggests that the secondary currency is
getting weaker and the base currency in turn is
getting stronger. They go up or down by units
known as pips or price interest point which is
almost identical to a tick in a stock price. It
is the smallest increment and a move from $1.2811
to $1.2821 is a 10 pip move upwards.

When trading the pairs, we should think in terms
of the base currency for buying and selling. If
we were to buy (long) the EUR/USD, it means that
we bought (long) the euro, hoping it to go up,
and selling (short) the dollar, hoping it will
fall. If we were to sell (short) the EUR/USD, it
means that we sold (short) the euro, hoping it to
fall and in turn buying (long) the dollar hoping
it to rise. There are different types of
transactions in the forex market. They are Spot
transactions, Forward transaction, Futures,
Options, and Swap.

In the Foreign Exchange markets we trade in lots,
which are in increments of 10,000s:

1 lot=10,000 units
2 lot=20,000 units
3 lot=30,000 units

The minimum one can purchase is 10,000 units of a
certain currency pair. For example, if we were to
buy 3 lots of the EUR/USD with the bid price at 1.
2811, we would spend $38,433 (30,000 ´ 1.2811= 25,
622). With buying 3 lots this means for every pip
that it goes up you make $3. So with movements of
some of these pairs, it's possible to generate
considerable profits.

It is important to remember that high risks
accompany any investment like forex market has
the potential for great returns. Proper knowledge,
studied information and risk management measures
can help the investors gain profit without the
fear of losing in their trade.

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