What is forex?

What Is Forex?

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 (if you’re a dude) or purse (if you’re a lady) or man purse (if you’re a metrosexual) into the currency of the country you are visiting.

You go up to the counter and notice a screen displaying different exchange rates for different currencies. 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!!!” (This excitement is quickly killed when you stop by a shop in the airport afterwards to buy a can of soda and, all of a sudden, half your money is gone.)

When you do this, you’ve essentially participated in the forex market! You’ve exchanged one currency for another. Or in forex trading terms, assuming you’re an American visiting Japan, you’ve sold dollars and bought yen.

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 exchanges rates that allow you to make money in the foreign exchange market.

The foreign exchange market, which is usually known as “forex” or “FX,” is the largest financial market in the world. Compared to the measly $22.4 billion a day volume of the New York Stock Exchange, the foreign exchange market looks absolutely ginormous with its $5 TRILLION a day trade volume. Forex rocks our socks!

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!

What Is Traded In Forex?

The simple answer is MONEY.

Because you’re not buying anything physical, forex trading can be confusing.

Think of buying a currency as buying a share in a particular country, kinda like buying stocks of a company. The price of the currency is a direct reflection of what the market thinks about the current and future health of the Japanese economy.

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.

In general, the exchange rate of a currency versus other currencies is a reflection of the condition of that country’s economy, compared to other countries’ economies.

By the time you graduate from this School of Pipsology, you’ll be eager to start working with currencies.

Major Currencies

Symbol Country Currency Nickname
USD United States Dollar Buck
EUR Euro zone members Euro Fiber
JPY Japan Yen Yen
GBP Great Britain Pound Cable
CHF Switzerland Franc Swissy
CAD Canada Dollar Loonie
AUD Australia Dollar Aussie
NZD New Zealand Dollar Kiwi

Currency symbols always have three letters, where the first two letters identify the name of the country and the third letter identifies the name of that country’s currency.

Take NZD for instance. NZ stands for New Zealand, while D stands for dollar. Easy enough, right?

The currencies included in the chart above are called the “majors” because they are the most widely traded ones.

Buying And Selling In Currency Pairs

Forex trading is the simultaneous buying of one currency and selling another. Currencies are traded through a broker or dealer, and are traded in pairs; 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. Exchange rates fluctuate based on which currency is stronger at the moment.

Major Currency Pairs

The currency pairs listed below are considered the “majors”. These pairs all contain the U.S. dollar (USD) on one side and are the most frequently traded. The majors are the most liquid and widely traded currency pairs in the world.

Currency Pair Countries FX Geek Speak
EUR/USD Euro zone / United States “euro dollar”
USD/JPY United States / Japan “dollar yen”
GBP/USD United Kingdom / United States “pound dollar”
USD/CHF United States/ Switzerland “dollar swissy”
USD/CAD United States / Canada “dollar loonie”
AUD/USD Australia / United States “aussie dollar”
NZD/USD New Zealand / United States “kiwi dollar”

Major Cross-Currency Pairs or Minor Currency Pairs

Currency pairs that don’t contain the U.S. dollar (USD) are known as cross-currency pairs or simply as the “crosses.” Major crosses are also known as “minors.” The most actively traded crosses are derived from the three major non-USD currencies: EUR, JPY, and GBP.

Euro Crosses

Currency Pair Countries FX Geek Speak
EUR/CHF Euro zone / Switzerland “euro swissy”
EUR/GBP Euro zone / United Kingdom “euro pound”
EUR/CAD Euro zone / Canada “euro loonie”
EUR/AUD Euro zone / Australia “euro aussie”
EUR/NZD Euro zone / New Zealand “euro kiwi”

Yen Crosses

Currency Pair Countries FX Geek Speak
EUR/JPY Euro zone / Japan “euro yen” or “yuppy”
GBP/JPY United Kingdom / Japan “pound yen” or “guppy”
CHF/JPY Switzerland / Japan “swissy yen”
CAD/JPY Canada / Japan “loonie yen”
AUD/JPY Australia / Japan “aussie yen”
NZD/JPY New Zealand / Japan “kiwi yen”

Pound Crosses

Pair Countries FX Geek Speak
GBP/CHF United Kingdom / Switzerland “pound swissy”
GBP/AUD United Kingdom / Australia “pound aussie”
GBP/CAD United Kingdom / Canada “pound loonie”
GBP/NZD United Kingdom / New Zealand “pound kiwi”

Other Crosses

Pair Countries FX Geek Speak
AUD/CHF Australia / Switzerland “aussie swissy”
AUD/CAD Australia / Canada “aussie loonie”
AUD/NZD Australia / New Zealand “aussie kiwi”
CAD/CHF Canada / Switzerland “loonie swissy”
NZD/CHF New Zealand / Switzerland “kiwi swissy”

NZD/CAD

New Zealand / Canada “kiwi loonie”

Market Size And Liquidity

Unlike other financial markets like the New York Stock Exchange, the forex market has neither a physical location nor a central exchange.

The forex market is considered an Over-the-Counter (OTC), or “Interbank” market due to the fact that the entire market is run electronically, within a network of banks, continuously over a 24-hour period.

This means that the spot forex market is spread all over the globe with no central location. They can take place anywhere, even at the top of Mt. Fuji!

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.

In the OTC market, participants determine who they want to trade with depending on trading conditions, attractiveness of prices, and reputation of the trading counterpart.

The chart below shows the ten most actively traded currencies.

The dollar is the most traded currency, taking 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 chart above shows just how often the U.S. dollar is traded in the forex market. It is on one side of a ridiculous 84.9% of all reported transactions!