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Quite simply, it’s the global market that allows one to trade two currencies
against each other.
If you think one currency will be stronger versus the other, and you end up
correct, then you can make a profit.
If you’ve ever traveled to another country, you usually had to find a currency
exchange booth at the airport, and then exchange the money you have in your
wallet into the currency of the country you are visiting.
An exchange rate is the relative price of two currencies from two different
countries.
You find “Japanese yen” and think to yourself, “WOW! My one dollar is worth
100 yen?! And I have ten dollars! I’m going to be rich!!!”
When you do this, you’ve essentially participated in the forex market!
Before you fly back home, you stop by the currency exchange booth to
exchange the yen that you miraculously have left over (Tokyo is expensive!)
and notice the exchange rates have changed.
It’s these changes in the exchange rates that allow you to make money in
the foreign exchange market.
What is forex?
The foreign exchange market, which is usually known as “forex” or “FX,” is
the largest financial market in the world.
Instead, most of the currency transactions that occur in the global foreign
exchange market are bought (and sold) for speculative reasons.
Currency traders (also known as currency speculators) buy currencies hoping
that they will be able to sell them at a higher price in the future.
Compared to the “measly” $22.4 billion per day volume of the New York Stock
Exchange (NYSE), the foreign exchange market looks absolutely ginormous
with its $6.6 TRILLION a day trade volume.
The largest stock market in the world, the New York Stock Exchange
(NYSE), trades a volume of about $22.4 billion each day. If we used a monster
to represent the NYSE, it would look like this…
Looks intimidating. Looks like it works out. Some may even find it sexy.
You hear about the NYSE in the news every day… on CNBC… on
Bloomberg…on BBC… heck, you even probably hear about it at your local
gym. “The NYSE is up today, blah, blah”.
When people talk about the “market”, they usually mean the stock market. So
the NYSE sounds big, it’s loud and likes to make a lot of noise.
But if you actually compare it to the forex market, it would look like this…
Oooh, the NYSE looks so puny compared to the forex market! It doesn’t stand
a chance!
Makes if you wonder if the “S” in NYSE stands for “Stock” or for
“Scrawny”? 🤣
Check out the graph of the average daily trading volume for the forex market,
New York Stock Exchange, Tokyo Stock Exchange, and London Stock
Exchange:
The currency market is over 200 times BIGGER! It is HUGE! But hold your
horses, there’s a catch!
That huge $6.6 trillion number covers the entire global foreign exchange
market, BUT the “spot” market, which is the part of the currency market that’s
relevant to most forex traders is smaller at $2 trillion per day.
And then, if you just want to count the daily trading volume from retail
traders (that’s us), it’s even smaller.
It is very difficult to determine the exact size of the retail segment of the FX
market, but it’s estimated to be around 3-5% of overall daily FX trading
volumes, or around $200-300 billion (maybe less).
So you see, the forex market is definitely huge, but not as huge as the others
would like you to believe.
Don’t believe the “forex is a $6.6 trillion market” hype! The huge number
sounds impressive, but a bit misleading. We don’t like to exaggerate. We just
keepin’ it real.
Aside from its size, the market also rarely closes! It’s open virtually round the
clock.
The forex market is open 24 hours a day and 5 days a week, only closing
down during the weekend. (What a bunch of slackers!)
So unlike the stock or bond markets, the forex market does NOT close at the
end of each business day.
Instead, trading just shifts to different financial centers around the world.
The day starts when traders wake up in Auckland/Wellington, then moves to
Sydney, Singapore, Hong Kong, Tokyo, Frankfurt, London, and finally, New
York, before trading starts all over again in Wellington!
In the next section, we’ll reveal WHAT exactly is traded in the forex market
Because you’re not buying anything physical, forex trading can be confusing
so we’ll use a simple (but imperfect) analogy to help explain.
In forex trading, when you buy, say, the Japanese yen, you are basically
buying a “share” in the Japanese economy.
You are betting that the Japanese economy is doing well, and will even get
better as time goes.
Once you sell those “shares” back to the market, hopefully, you will end up
with a profit.
By the time you graduate from this School of Pipsology, you’ll be eager to start
working with currencies.
Major Currencies
While there are potentially lots of currencies you can trade, as a
new forex trader, you will probably start trading with the “major currencies“.
They’re called “major currencies” because they’re the most heavily traded
currencies and represent some of the world’s largest economies.
The uptight ones who probably got straight A’s and followed all the rules as
children only consider USD, EUR, JPY, GBP, and CHF as major currencies.
For us rebels, and to keep things simple, we just consider all eight currencies
as the “majors”.
Below, we list them by their symbol, country where they’re used, currency
name, and cool nicknames.
The currencies included in the chart above are called the “majors” because
they are the most widely traded ones.
DID YOU KNOW? The British pound is the world’s oldest currency that’s still in use,
dating back to the 8th century. The newest currency in the world is the South Sudanese
pound, made official on July 18, 2011.
We’d also like to let you know that “buck” isn’t the only nickname for USD.
There’s also: greenbacks, bones, benjis, benjamins, cheddar, paper, loot,
scrilla, cheese, bread, moolah, dead presidents, and cash money.
Instead, you could say, “Yo, I gotta bounce! Gotta make them benjis son!”
FUN FACT: In Peru, a nickname for the U.S. dollar is Coco, which is a pet
name for Jorge (George in Spanish), a reference to the portrait of George
Washington on the $1 note?
For example, the euro and the U.S. dollar (EUR/USD) or the British pound and
the Japanese yen (GBP/JPY).
When you trade in the forex market, you buy or sell in currency pairs.
Imagine each currency pair constantly in a “tug of war” with each currency on
its own side of the rope.
An exchange rate is the relative price of two currencies from two different
countries.
1. The “majors“
2. The “crosses“
3. The “exotics“
Cross-currency pairs do NOT include the U.S. dollar. Crosses that involve any
of the major currencies are also known as ” minors”.
Exotic currency pairs consist of one major currency and one currency from an
emerging market (EM).
These pairs all contain the U.S. dollar (USD) on one side and are the most
frequently traded.
Compared to the crosses and exotics, price moves more frequently with the
majors, which provide more trading opportunities.
CURRENCY
COUNTRIES FX GEEK SPEAK
PAIR
In forex, it’s based on the number of active traders buying and selling a
specific currency pair and the volume being traded.
The more frequently traded something is, the higher its liquidity.
For example, more people trade the EUR/USD currency pair and at higher
volumes, than the AUD/USD currency pair.
While not as frequently traded as the majors, the crosses are still pretty liquid
and still provide plenty of trading opportunities.
The most actively traded crosses are derived from the three major non-USD
currencies: EUR, JPY, and GBP.
Euro Crosses
CURRENCY
COUNTRIES FX GEEK SPEAK
PAIR
Yen Crosses
CURRENCY
COUNTRIES FX GEEK SPEAK
PAIR
No, exotic pairs are not exotic belly dancers who happen to be twins.
Exotic currency pairs are made up of one major currency paired with the
currency of an emerging economy, such as Brazil, Mexico, Chile, Turkey, or
Hungary.
The chart below contains a few examples of exotic currency pairs.
Wanna take a shot at guessing what those other currency symbols stand for?
Depending on your forex broker, you may see the following exotic currency
pairs so it’s good to know what they are.
Keep in mind that these pairs aren’t as heavily traded as the “majors” or
“crosses,” so the transaction costs associated with trading these pairs are
usually bigger.
CURRENCY
COUNTRIES FX GEEK SPEAK
PAIR
It’s not unusual to see spreads that are two or three times bigger than that of
EUR/USD or USD/JPY.
Due to the overall lower degree of liquidity, exotic currency pairs tend to be far
more sensitive to economic and geopolitical events.
So if you want to trade exotics currency pairs, remember to factor this in your
decision.
For those of y’all who are really mesmerized by exotics, here’s a more
comprehensive list.
CURRENCY CODE COUNTRY CURRENCY CODE COUNTRY
DID YOU KNOW? There are 180 legal currencies in the world, as recognized by the
United Nations. That’s a lot of potential currency pairs! Unfortunately, not all of them are
readable. Forex brokers tend to offer traders up to 70 currency pairs.
Aside from the three main categories of currency pairs, there are other
“groups” of currencies that are thrown around in the FX world which you
should be aware of.
G10 Currencies
The G10 currencies are ten of the most heavily traded currencies in the world,
which are also ten of the world’s most liquid currencies.
Traders regularly buy and sell them in an open market with minimal impact on
their own international exchange rates.
European
euro EUR
Union
United
pound GBP
Kingdom
The Scandies
Scandinavia is a subregion in Northern Europe, with strong historical, cultural,
and linguistic ties.
This meant that these countries now had one currency, with the same
monetary value, with the exception that each of these countries minted their
own coins.
But then World War I happened, and the gold standard was abandoned and
the Scandinavian Monetary Union disbanded. These countries decided to
keep the currency, even if the values were separate from one another. And
this remains the state of things.
If you notice their currency names, they all look similar. That’s because the
word “krone or krona” literally means “crown”, and the differences in spelling of
the name represent the differences between the North Germanic languages.
Crown currencies. What a cool name huh?
I don’t know about you, but saying “Hook me up with some crowns yo.” sounds
way cooler than “Hook me up with some dollahs yo.”
SEK and NOK also have cool nicknames, “Stockie” and “Nokie“.
So when paired with the U.S. dollar, USD/SEK is read “dollar stockie” and
USD/NOK is read “dollar nockie”.
CEE Currencies
“CEE” stands for Central and Eastern Europe.
Central and Eastern European Countries (CEECs) is an OECD term for the
group of countries comprising Albania, Bulgaria, Croatia, the Czech Republic,
Hungary, Poland, Romania, the Slovak Republic, Slovenia, and the three
Baltic States: Estonia, Latvia, and Lithuania.
Regarding the FX market, there are four main CEE currencies to be aware of.
BRIICS
BRIICS is the acronym coined for the association of five major emerging
national economies: Brazil, Russia, India, Indonesia, China, and South Africa.
Originally the first four were grouped as “BRIC” (or “the BRICs”). BRICs was a
term created by Goldman Sachs to name today’s new high-growth emerging
economies.
BRIICS is the term created by the OECD, when it added Indonesia and South
Africa.
COUNTRY CURRENCY NAME CURRENCY CODE
South
rand ZAR
Africa
Summary
Whew! That was a lot of information on currencies but you just raised your FX
IQ points! 🧠
Unlike other financial markets like the New York Stock Exchange (NYSE)
or London Stock Exchange (LSE), the forex market has neither a physical
location nor a central exchange.
This means that the FX market is spread all over the globe with no central
location.
Trades can take place anywhere as long as you have an Internet connection!
The forex OTC market is by far the biggest and most popular financial market
in the world, traded globally by a large number of individuals and
organizations.
The chart below shows the seven most actively traded currencies.
*Because two currencies are involved in each transaction, the sum of the percentage shares of
individual currencies totals 200% instead of 100%
The U.S. dollar is the most traded currency, making up 84.9% of all
transactions!
The euro’s share is second at 39.1%, while that of the yen is third at 19.0%.
As you can see, most of the major currencies are hogging the top spots on this
list!
The Dollar is King in the Forex Market
You’ve probably noticed how often we keep mentioning the U.S. dollar (USD).
If the USD is one-half of every major currency pair, and the majors
comprise 75% of all trades, then it’s a must to pay attention to the U.S. dollar.
The USD is king!
In fact, according to the International Monetary Fund (IMF), the U.S. dollar
comprises roughly 62% of the world’s official foreign exchange reserves!
There are also other significant reasons why the U.S. dollar plays a central
role in the forex market:
• The United States has the largest and most liquid financial markets in the
world.
In other words, most of the trading volume comes from traders that buy and
sell based on the short-term price movements of currency pairs.
The trading volume brought about by speculators is estimated to be more than
90%!
The scale of the forex market means that liquidity – the amount of buying
and selling volume happening at any given time – is extremely high.
This makes it very easy for anyone to buy and sell currencies.
In our forex trading sessions part of the School, we’ll explain how the time of
your trades can affect the pair you’re trading.
In the meantime, let’s learn about the different ways that individuals can
trade currencies.
The Different Ways To Trade Forex
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Among the financial instruments, the most popular ones are retail forex, spot
FX, currency futures, currency options, currency exchange-traded funds (or
ETFs), forex CFDs, and forex spread betting.
It’s important to point out that we are covering the different ways
that individual (“retail”) traders can trade FX.
Other financial instruments like FX swaps and forwards are not covered since
they cater to institutional traders.
With that out of the way, let’s now discuss how you can partake in the world of
forex.
Currency Futures
Futures are contracts to buy or sell a certain asset at a specified price on a
future date (That’s why they’re called futures!).
A currency future is a contract that details the price at which a currency could
be bought or sold, and sets a specific date for the exchange.
This means that price and transaction information are readily available.
Currency Options
An “option” is a financial instrument that gives the buyer the right or the option,
but not the obligation, to buy or sell an asset at a specified price on the
option’s expiration date.
Currency ETFs
A currency ETF offers exposure to a single currency or basket of currencies.
Currency ETFs allow ordinary individuals to gain exposure to the forex market
through a managed fund without the burdens of placing individual trades.
ETFs are created and managed by financial institutions that buy and hold
currencies in a fund. They then offer shares of the fund to the public on an
exchange allowing you to buy and trade these shares just like stocks.
Like currency options, the limitation in trading currency ETFs is that the market
isn’t open 24 hours. Also, ETFs are subject to trading commissions and other
transaction costs.
Spot FX
The spot FX market is an “off-exchange” market, also known as an over-the-
counter (“OTC”) market.
The off-exchange forex market is a large, growing, and liquid financial market
that operates 24 hours a day.
It is not a market in the traditional sense because there is no central trading
location or “exchange”.
Unlike currency futures, ETFs, and (most) currency options, which are traded
through centralized markets, spot FX are over-the-counter contracts (private
agreements between two parties).
The primary market for FX is the “interdealer” market where FX dealers trade
with each other. A dealer is a financial intermediary that stands ready to buy or
sell currencies at any time with its clients.
The interdealer market is also known as the “interbank” market due to the
dominance of banks as FX dealers.
So if you buy EUR/USD on the spot market, you are trading a contract that
specifies that you will receive a specific amount of euros in exchange for U.S
dollars at an agreed-upon price (or exchange rate).
It’s important to point out that you are NOT trading the underlying currencies
themselves, but a contract involving the underlying currencies.
Even though it’s called “spot”, transactions aren’t exactly settled “on the spot”.
In reality, while a spot FX trade is done at the current market rate, the actual
transaction is not settled until two business days after the trade date.
It means that delivery of what you buy or sell should be done within two
working days and is referred to as the value date or delivery date.
The trade opened and closed on Monday has a value date on Wednesday.
This means that it’ll receive euros on Wednesday.
Not all currencies settle T+2 though. For example, USD/CAD, USD/TRY,
USD/RUB and USD/PHP value date is T+1, meaning one business day going
forward from today (T).
Trading in the actual spot forex market is NOT where retail traders trade
though.
Retail Forex
There is a secondary OTC market that provides a way for retail (“poorer”)
traders to participate in the forex market.
Forex trading providers trade in the primary OTC market on your behalf. They
find the best available prices and then add a “markup” before displaying the
prices on their trading platforms.
This is similar to how a retail store buys inventory from a wholesale market,
adds a markup, and shows a “retail” price to their customers.
Forex trading providers are also known as “forex brokers”. Technically, they
are not brokers because a broker is supposed to simply act as a middleman between a
buyer and a seller (“between two parties”). But this is not the case, because a forex
trading provider acts as your counterparty. This means if you are the buyer, it acts as the
seller. And if you are the seller, it acts as the buyer. To keep things simple for now, we will
still use the term “forex broker” since that’s what most people are familiar with but it’s
important to know the difference.
Although a spot forex contract normally requires delivery of currency within two
days, in practice, nobody takes delivery of any currency in forex trading.
Retail forex traders can’t “take or make delivery” on leveraged spot forex
contracts.
Leverage allows you to control large amounts of currency for a very small
amount.
Retail forex brokers let you trade with leverage which is why you can open
positions valued at 50 times the amount of the initial required margin.
Imagine if you went short EUR/USD and had to deliver $100,000 worth of
euros!
You’d be unable to settle the contract in cash since you only have $2,000 in
your account. You wouldn’t have enough funds to cover the transaction!
So you either have to close the trade before it settles or “roll” it over.
To avoid this hassle of physical delivery, retail forex brokers automatically “roll”
client positions.
When a spot forex transaction is not physically delivered but just indefinitely rolled forward
until the trade is closed, it is known as a “rolling spot forex transaction” or “rolling spot
FX contract“. In the U.S., the CFTC calls it a “retail forex transaction“.
This is how you avoid being forced to accept (or deliver) 100,000 euros.
Retail forex transactions are closed out by entering into an equal but
opposite transaction with your forex broker.
For example, if you bought British pounds with U.S. dollars, you would close
out the trade by selling British pounds for U.S. dollars.
If you have a position left open at the close of the business day, it will be
automatically rolled over to the next value date to avoid the delivery of the
currency.
Your retail forex broker will automatically keep on rolling over your spot
contract for you indefinitely until it is closed.
When positions are rolled over, this results in either interest being paid or
earned by the trader.
These charges are known as a swap fee or rollover fee. Your forex broker
calculates the fee for you and will either debit or credit your account balance.
Retail forex trading is considered speculative. This means traders are trying
to “speculate” or make bets on (and profit from) the movement of exchange
rates. They’re not looking to take physical possession of the currencies they
buy or deliver the currencies they sell
A currency pair’s price being used on the spread bet is “derived” from the
currency pair’s price on the spot FX market.
Your profit or loss is dictated by how far the market moves in your favor before
you close your position and how much money you have bet per “point” of price
movement.
Forex CFD
A contract for difference (“CFD”) is a financial derivative. Derivative products
track the market price of an underlying asset so that traders can speculate on
whether the price will rise or fall.
A CFD is a contract, typically between a CFD provider and a trader, where one
party agrees to pay the other the difference in the value of a security,
between the opening and closing of the trade.
A currency pair’s CFD price is “derived” from the currency pair’s price on the
spot FX market. (Or at least it should be. If not, what is the CFD provider
basing its price on? 🤔)
Trading forex CFDs gives you the opportunity to trade a currency pair
in both directions. You can take both long and short positions.
If the price moves in your chosen direction, you would make a profit, and if it
moves against you, you would make a loss.
In the EU and UK, regulators decided that “rolling spot FX contracts” are
different from the traditional spot FX contract.
The main reason being is that with rolling spot FX contracts, there is no
intention to ever take actual physical delivery (“take ownership”) of a currency,
its purpose is to simply speculate on the price movement in the
underlying currency.
Outside the U.S., retail forex trading is usually done with CFDs or spread bets.