The Forex Market Affects Every Country in the World but IS Much Simpler to Follow and Understand than You Think.
While foreign currency is traded around in and by every country in the world, forex trading does not require familiarity with every currency in the world. Unlike the stock exchange, in which there are literally thousands of possibilities to choose from, the forex market is relatively simple to follow because the vast majority of forex trading involves just eight currencies.
These global currencies are dubbed the Eight Majors. They are the anchors of foreign trade that most countries use to trade with the rest of the world. They are anchors because of their long-term stability, global availability, and the large amount of trade conducted between the countries that use them as legal tender. The Eight Majors are the U.S dollar, the euro, the British pound sterling, the Swiss franc, and the Canadian, Australian and New Zealand dollars. Countries that issue their own currencies will still prefer to use the Eight Majors in international trade since their flow back and forth into their own local banks makes it easier to process future imports and exports, which is the lifeblood of international economics.
Currency Pairs, Base and Terms
It takes two to tango. Trading forex always involved two currencies, which are known as a currency pair when one of the two is the U.S. dollar. When neither of the two is the U.S. dollar, the currencies are called cross-currency pairs. In both cases, the first is known as the base currency and the second the terms currency (sometimes called the counter currency or quote currency). The base currency is the current value of a currency in relation to another that is being acquired. The terms currency is the currency that is being used to buy the other.
For purposes of notation, currency pairs are abbreviated using three letters: EUR for the euro, USD for U.S. dollars, GBP for the pound sterling, CHF for Swiss francs, JPY for Japanese yen, CAD for Canadian dollars, AUD for Australian dollars, and NZD for New Zealand dollars. A trade in which U.S. dollars are used to purchase pounds sterling, for example, is abbreviated as GBPUSD=1.390, assuming that $1.39 in U.S. currency is required to purchase one British pound.
Bid, Ask and Spread
The bid is the price the dealer demands while the ask is the price the buyer offers. The bid is typically lower than the asking price for the simple reason that a deal would otherwise not be profitable, unless there is a rare run on the currency, something that almost never happens with the Eight Majors. The spread is the difference between the bid and the asking price. To calculate the spread, simply subtract the asking price from the bid.
The two most common forex trading strategies are known as long and short positions, which obviously refer to the amount of time the investor holds on to foreign currency before trading it.
An investor who takes a long position aims to purchase base currency in the expectation that it will increase in value against the terms currency. This is also known colloquially as “going long.” An investor who takes a short position intends to sell the terms currency in the expectation that it will strengthen against the base currency. This is also known colloquially as “going short.”
Keep in mind that the daily fluctuations between the exchange rates of the Eight Majors rarely exceed 1%. Under those conditions, profits will remain limited. For that reason, forex brokers offer their clients a multiplier, which enables them to buy exponentially larger amounts of forex than their initial investment would otherwise allow. For investors in the know, the multiplier is a valuable tool that allows them to maximize their trade and their profit.