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Foreign Exchange

Foreign Exchange

What is Foreign exchange?

Foreign exchange, otherwise known as forex, or FX, refers to the exchange – or purchase – of one currency for another. Rates of exchange are constantly fluctuating, sometimes greatly, other times only slightly. Exchange rates are always presented in pairs, known as currency pairs. The first currency in the pair is known as the base currency and is always equal to 1. The second currency is the quote currency, and is the equivalent of one unit of the base currency. For example, if the EUR/USD is trading at 1.1150, that means that one euro is the equivalent of 1.1150 U.S. dollars. If the rate of exchange goes up, that indicates that the euro has grown stronger against the dollar, because one euro will be able to buy more dollars than previously. If the rate drops, then the U.S. dollar has grown stronger against the euro. Three types of currency pairs are traded on forex markets:

  • Majors pair the U.S. dollar with each of the six major currencies – the euro, Japanese yen, British pound, Swiss franc, Canadian dollar, Australian dollar, and New Zealand dollar.
  • Minors/Cross currencies pair the euro, Japanese yen or British pound with other majors, except the U.S. dollar.
  • Exotics pair one of the seven Majors with a currency not on that list, generally with a lower trading volume.

How do forex traders use Foreign exchange?

Forex traders buy and sell foreign currencies, speculating what the price movement will be in either the short- or long-term future.  When a trader takes what is known as a long position, he purchases a currency, with the expectation that the price will rise and he can sell it back at the higher price for a profit. Alternately, a trader who sells a currency, or takes a short position, believes that the price of that currency will drop and he can buy back the units at a later date, paying less for them than he received to sell them.

Traders can also trade on currency CFDs, in which they do not actually take ownership of the currency, but they invest on the price movement of the currency pair.

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