Introduction to the Foreign Exchange Market

With daily volumes of 4 trillion USD, the Foreign Exchange or Forex is the largest financial Market in the world. The Forex market operates as a decentralized network where the world's major currencies can be traded one against another, in a 24-hour basis, from Monday to Friday.

 

The Short History of the Modern Currency Market

After the end of World War II, the Bretton Woods Agreement (1944) became the basis of a new global monetary system. According to that agreement, the exchange value of a country’s currency was fixed and equal to a particular quantity of gold. Since the Bretton Woods Agreement ended, during the 70s, the current Floating Currency System has arisen. According to the modern Floating System, the value of every currency rises or falls according to the dynamics of demand and supply.

• In 1971, the CME (Chicago Mercantile Exchange) was the first exchange to offer currency trading within the International Monetary Market (IMM)
• After 1990, the revolution in Informational Technology provided the framework for a new fully-computerized Forex Market, the Online Forex Market
• Today there are many hundreds of Online Brokers offering access to the Foreign Exchange market. These brokerage firms are divided into three main categories:

(1) ECN Brokers (Non-Dealing-Desk)

(2) STP Brokers (Non-Dealing-Desk)

(3) Market Makers (Dealing-Desk)

The Interbank Market

The Interbank market is the market where large banks are executing currency transactions. The Interbank market is also called the Institutional Forex Market.

The Electronic Communication Network (ECN)

The electronic communication network (ECN) is a decentralized network that automatically matches buy and sell orders when trading currency pairs. The ECN network allows investors located in different geographic areas to make transactions without the need for a third party. » More about the ECN network

Most Traded Forex Currencies

The most-traded Forex currencies are the USD (United States dollar), EUR (Euro), JPY (Japanese Yen), GBP (Pound Sterling), AUD (Australian dollar), CHF (Swiss Franc), CAD (Canadian dollar), and NZD (New Zealand dollar).

Forex Market Participants

Forex market participants include central banks, large and small commercial banks, investment companies, retail and institutional traders, brokers, large importers/exporters, and even international tourists.

Main Trading Advantages

As is already mentioned Forex is a huge market and huge markets are usually providing strong benefits to their participants:

(1) Forex Trading can take place anywhere in the world using a desktop or mobile PC, and an internet connection

(2) High liquidity and strong competition leads to low transaction cost

(3) There is the option for high Capital Leverage which enables Forex participants to open positions by depositing only a small portion of the total value of their trades

(4) There are many innovative tools exclusively designed for the Forex Market (automated platforms, FIX/API, Expert Advisors, etc)

Key Factors Affecting World's Exchange Rates

Many different events can cause notable fluctuations in the global currency market:

(1) Changes in the monetary policies of Central Banks, especially concerning their interest rate policies

(2) Key macroeconomic releases, especially concerning inflation, unemployment, and growth » Learn more on Forex fundamentals

(3) Political and strategic factors which may lead to the increase in political risk

(4) Business conditions, and changes in government legislation (such as capital restrictions)

(5) Psychological factors and market expectations (during times of global financial turmoil expect the US Dollar to rise)

 

Basic Forex Terms

These are some basic terms when trading the Foreign Exchange market:

• Bid/Ask Price

All Forex pairs are quoted with two prices: the bid and the asking price. The bid price is the price at which a Forex broker is willing to buy and thus a trader can sell a currency at that price. The asking price is the price at which a Forex broker is willing to sell and thus a Forex trader may buy at that particular price.

• Trading Spread

Measured in pips, the spread is the difference between the bid and ask price. For example, if the bid price is 1.1000 and the asking price is 1.1002, the spread is 2 pip. Narrow spreads mean less transaction cost for Forex traders, something important for intraday traders. Major Forex pairs such as EUR/USD, GBP/USD, and USD/JPY are offered in tighter spreads than other pairs.

• Pip

A pip is the minimum incremental move of any Forex currency pair. For example, in the EURUSD pair, a pip is equal to a movement from 1.1000 to 1.1001.

• Trading Leverage

In a typical financial market, to execute a trade worth $1,000, you must first deposit $1,000. In the Foreign exchange market, an investor can execute a trade only by depositing a small part of the value of the trade which is called MARGIN. The ratio between the value of the margin required and the value of the trade is called LEVERAGE. The maximum trading leverage when trading Forex in the European Union is 30:1.

• Standard Lot

For USD-based currency pairs, the standard lot size is 100,000 USD. A standard lot is one of the three common lot sizes, along with mini-lot and micro-lot. The smaller your lot size, the more flexible you can be when you manage your trades.

(1) Micro Lot (best choice for beginners)

A micro lot is the smallest tradable lot of 1,000 units of currency. If a trading account is funded in USD then a micro lot is worth $1,000 of the base currency. Thus when trading a US dollar-based pair, 1 pip is equal to 10 cents.

(2) Mini Lot (best choice for the average retail trader)

A mini lot is 10,000 units of the trading account funding currency. In a US dollar-based account, each pip is worth $1.

(3) Standard Lot (professional traders)

A standard lot worth 100,000 units. In a US trading account, a standard lot is worth $100,000. The typical pip size in a standard lot account is worth $10.

 

 

Currency Quotation and the Categories of Forex Pairs

Forex trading means trading a pair of two different currencies. All currencies in the Forex Market are traded one against another. For example, the Euro against the US Dollar forms the EURUSD currency pair. The first currency of any currency pair is called the Base Currency and the second currency pair is called the Quote Currency.

◙ EURUSD pair (Euro is the Base Currency and the US Dollar is the Quote Currency)

At any currency quote, the value of the base currency is always 1, for example in EURUSD 1 Euro is quoted against one US Dollar.

Major Forex Currency Pairs

The major pairs are those pairs with the highest trading activity in the Forex Market.

Currency Pair	Countries	Typical Market Spread (No commissions)	Forex Slang
EURUSD	Euro against the United States Dollar	1.0 pip	Euro-dollar
USDJPY	United States Dollar against the Japanese Yen	1.4 pip	Dollar-yen
GBPUSD	British Pound against the United States Dollar	1.5 pip	Cable
USDCAD	United States Dollar against the Canadian Dollar	2.0 pip	Loonie
USDCHF	United States Dollar against the Swiss Franc	2.0 pip	Swissy
AUDUSD	Australian Dollar against the United States Dollar	2.5 pip	Aussie
NZDUSD	New Zealand Dollar against the United States Dollar	2.7 pip	Kiwi

Forex Crosses

Forex crosses are currency pairs that do not include the United States Dollar.

(1) European Currency (Euro) Crosses

Currency Pair	Forex Currencies	Typical Market Spread
EURCHF	Euro-Swiss Franc	2.4 pip
EURGBP	Euro-British Sterling	2.0 pip
EURCAD	Euro-Canadian Dollar	2.4 pip
EURAUD	Euro- Australian Dollar	2.8 pip
EURNZD	Euro-New Zealand Dollar	4.0 pip

(2) British Pound Crosses

Currency Pair	Forex Currencies	Typical Market Spread
GBPCHF	British Sterling-Swiss Franc	3.0 pip
GBPAUD	British Sterling- Australian Dollar	3.0 pip
GBPCAD	British Sterling-Canadian Dollar	4.0 pip
GBPNZD	British Sterling-New Zealand Dollar	6.5 pip

(3) Japanese Yen Crosses

Currency Pair	Forex Currencies	Typical Market Spread
EURJPY	Euro-Japanese Yen	1.8 pip
GBPJPY	British Sterling- Japanese Yen	3.0 pip
AUDJPY	Australian Dollar - Japanese Yen	2.4 pip
NZDJPY	New Zealand Dollar - Japanese Yen	2.6 pip
CADJPY	Canadian Dollar - Japanese Yen	2.6 pip
CHFJPY	Swiss Franc- Japanese Yen	2.5 pip

Exotic Forex Pairs

Exotic currencies are currencies consisting of the US Dollar or the European Euro against the currency of a developing country. For example the US Dollar against the Turkish Lira.

• The spread when trading exotic pairs is significantly more expensive than trading the above-mentioned pairs

 

 

Key Forex Trading Strategies

There are many different Forex Trading Strategies designed to fit various trading profiles:

(1) Forex Scalping Strategies

Scalpers are executing tens of trades daily to benefit from tiny movements in the exchange rates. They buy and sell currency pairs in a matter of minutes or even seconds. » Forex Scalping Strategies

(2) Automated Forex Trading

Automated trading using Expert Advisors has become very popular. This type of trading is based on specialized software scripts running on a platform without human intervention. » Creating custom Forex trading strategies

(3) Price Action Strategies

This kind of strategy analyzes clean charts (non-indicator charts). Price action strategies aim to use the core price data of a Forex market. » Price Action Strategies

(4) News-Trading Strategies

These strategies focus exclusively on the news and aim to exploit market inefficiencies based on news and recent developments in the currency market. » Trading-the-News Strategies

(5) Swing-Trading Strategies

Swing trading is a trading strategy that focuses on short to medium-term timeframes and aims to profit from strong price trends or else price 'swings' » Swing-Trading Strategies

(6) Carry-Trading Strategies

Carry trade is a very popular Forex investing strategy that involves borrowing or selling a Forex currency with a low-interest rate, and at the same time buying a Forex currency with a higher interest rate. » Carry-Trading Strategies

» Key Forex Trading Strategies

Choosing Forex Brokers

There are hundreds of different Forex Brokers providing online trading. A trader should choose a broker based on the following criteria:

(1) The safety of money

(2) The trading cost (ECN Forex brokers offer the narrowest spreads and the lowest commissions)

(3) Trading options (such as funding methods, automated trading, available platforms, etc.)

(4) Technology (technological inefficiencies like delays in execution may cause many problems to traders, especially to intraday traders)

 

Here is a list of Forex Brokers and the welcome bonus policy they offer: » More on Forex Brokers

 

■ Forex Trading Guide

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