Introduction to Forex

Introduction to Forex

Let’s take a closer look at the forex market, to understand what it is, exactly.

Forex is the trade in currencies. The word is a combination of “foreign exchange,” the technical term for trading one currency for another. Forex is a highly active market, and since it is quite literally the trade in cash it is a purely liquid market. Overall, the world’s forex marketplace accounts for more than 5 trillion US dollars per day in trading activity, making it by far the world’s largest financial marketplace.

Every forex trade is conducted in a pair, which makes logical sense. A pair consists of a base currency (the first one listed) and a quote currency (the second one listed). To give an example, the trade in US dollars and Japanese yen is listed as the USD/JPY pair. The exchange rate given is the value of the base currency in the quote currency, so when a trader sees USD/JPY 107.75 that means that one US dollar buys 107.75 Japanese yen.

In forex trading, the pairs are always shown with two prices listed. The first price shown is the BID price and the second price shown is the ASK price. The BID price is always lower than the ASK price. A trader who wants to sell a currency pair will receive the BID price. A trader buying the pair will pay the ASK price.

In our example above, with the USD/JPY, a trader may see a bid price of 107.74 and an ask price of 107.76. The difference between the two is called the spread. In our example, the spread is 2 pips (one pip is the final decimal point in a forex quote).

For a trader, the heart of the forex markets is finding profits in the way that currencies’ exchange rates change. In order to understand those changes, and to make the profitable trades, it is important to understand the background of the market, and why currencies change in value.

Some important factors to look at in currency trading are the economic trends affecting the currencies’ issuing countries, the geopolitical events around those countries, and the market sentiment towards the currencies.

Economic trends and geopolitical events are the items that make into the headlines of the major newspapers and news websites. If a country shows stronger or weaker than expected economic growth, or if there is a war, trade agreement, or natural disaster, it can increase or decrease the demand for particular currencies. To give an example, the recent rise in the price of oil helped to boost the Canadian dollar, as Canada is a major oil exporter.

Market sentiment is related to the first two factors; it is the overall “feeling” of traders in the forex markets. Think of it as the sum of all trades in the currency markets, and the practical effect of traders’ reactions to economic and geopolitical news. Market sentiment may usually be less than tangible, but it always makes itself felt. However, it’s something that a trader will have to learn by experience.