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What is the foreign exchange market?
Forex (forex or FX) refers to global over-the-counter trading (OTC) in which traders, investors, institutions and banks buy and sell to invest in currencies around the world.
Trading is carried out through the online channel ‘Interbank Market’ and is traded 24 hours a day on weekdays. The foreign exchange market is the world’s largest trading market, with daily trading volume estimated at over $5 trillion.
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Designed for beginners, FBS’s beginner’s guide introduces foreign exchange terminology. We answer frequently asked questions and, above all, make it easy to understand.
Understanding currency pairs
All trades in the Forex market involve buying and selling of both currencies at the same time.
This is called a ‘currency pair’ and consists of a base currency and a display currency. Shown below is the EUR/USD (Euro/US Dollar), the most traded currency pair on the Forex market.
- BASE CURRENCY
- The base currency is the currency that comes first in the currency pair. This base currency is bought or sold and exchanged for the display currency. Based on the example above, you would have to pay 1.0916 USD to buy 1 EUR. Conversely, you can sell 1 EUR and exchange it for 1.0916 USD.
- DISPLAY CURRENCY
- The display currency (counter-currency) is the currency that comes last in the currency pair.
- BID QUOTE
- The bid price is the price at which a trader is willing to buy a currency pair. Presented in real time and constantly updated.
- Ask is the price at which a trader is willing to sell a currency. Prices presented in real time, constantly changing in response to market demand and the political and economic factors that affect the value of individual currencies.
- Spread is the difference between Ask and Bid prices. In other words, transaction costs. For example, if EUR/USD is trading with an Ask price of 1.0918 and a Bid price of 1.0916, the spread will be the Ask price minus the Bid price. In this case, it is 0.0002.
- A pip is an abbreviation for Point in price, which is a unit that indicates the price fluctuation of a currency pair in the foreign exchange market. It is sometimes an abbreviation for “Percentage in point” and “price interest point”. A pip is used to judge price movement and represents the price movement of a currency pair. Most currency pairs are displayed to 5 decimal places.
Transactions and Key Terms
A ‘Position’ is a term used to describe a trade that is currently in progress. A long position is a trade that is bought with the expectation that the price will rise. If you sell that currency back to the market (ideally at a higher price than your buy), the long position is said to be ‘closed’ and the trade is completed.
short position is a trade in which you expect the price to decrease and you want to sell a currency and later buy it at a lower price. A short position is ‘closed’ when the asset is repurchased (ideally at a lower selling price).
For example, if the EUR/USD currency pair is trading at 1.0916/1.0918, an investor looking to open a long position in the Euro will buy 1 EUR at 1.0918 USD. Investors make a profit by holding on to the euro in the hope that it will rise and then selling it back to the market when the price rises.
An investor looking to take a short position against EUR sells 1 EUR at 1.0916 USD. The investor expects the euro to depreciate and will buy again if it does.
What are the most traded currency pairs on the foreign exchange market?
There are 7 major currency pairs in the foreign exchange market. Others include crosses and exotic currency pairs that trade less than the majors and are relatively less liquid (not easy to monetize).
1. Major currency pairs
The major currency pairs are the most traded on the foreign exchange market, accounting for about 80% of total trading volume.
Major currency pairs are generally less volatile and more liquid.
As a currency pair of a stable country with a well-managed economy, price manipulation is difficult and spreads are lower than other currency pairs.
2. Cross currency pairs
Cross Currency Pairs – Crosses are currency pairs that do not include USD.
In the past, crosses were first exchanged for USD and then for the currency of your choice, but now you can exchange them directly.
The most traded cross currency pairs are those derived from the minor currency pairs (eg EUR/GBP, EUR/JPY, GBP/JPY), which are generally less liquid and more volatile than the major currency pairs.
3. Exotic currency pairs
Exotics are currency pairs made up of a major and a currency of a sub-emerging country.
Compared to crosses and majors, exotics have less liquidity, greater volatility, and higher risk of investment because they are vulnerable to market manipulation.
They are also more vulnerable to sudden changes in political and financial conditions due to their large spreads.
The table below shows the different currency pairs for each bracket and the aliases created by the traders.
Understand FOREX CHART
1. Candlestick chart
Candles (Japanese candle charts) are preferred by traders because they show a variety of information. Charts show high, low, open, and close prices.
A candle consists of three points: open, close and tail.
The tail shows the high and low ranges, and the ‘body’ (chubby part) shows whether the closing price is above or below the open price.
If the candle is filled, the closing price is lower than the opening price. If the candle is empty, the closing price is higher than the opening price.
2. Bar chart
Bar charts show open, close, high and low prices.
The upper end of the bar represents the highest price and the lower end of the bar represents the lowest traded price during that specific period.
The body of the bar represents the overall range of the currency pair, and the horizontal lines next to it represent the opening (left) and closing (right) prices.
Bar charts are often used to confirm the narrowing and widening of price fluctuations.
3. Line chart
Line charts are easy for beginners to understand. Line charts connect closing prices with lines.
Connecting the closing price with a line makes it easy to see price movement over a specific period and reveals currency patterns.