To understand the term Forex in “simple” words, let’s take a scenario …
Let say you live in USA and decides to travel to Japan in Summer Holidays.
Like any other traveler, you have to find a currency exchange booth at the airport, and then exchange the money you have in wallet into the currency of Japan i.e. Yen.
You go up to the counter and notice a screen displaying different exchange rates for different currencies.
An exchange rate is the relative price of two currencies from two different countries.
You find “Japanese yen” and think to yourself, “WOW! My one dollar is worth 100 yen?! And I have one thousand dollars! I’m going to be rich!!!”
You sold American Dollars and bought Japanese Yen. When you do this, you’ve essentially participated in the forex market!
You’ve exchanged one currency for another. In a sense you have become a Forex trader, unknowingly!
Before you fly back home, you stop by the currency exchange booth to exchange the yen that you miraculously have remaining (Tokyo is expensive!) and notice the exchange rates have changed. Now your one dollar is worth 101 Yen.
It’s these changes in the exchange rates that allow you to make money in the foreign exchange market.
Now the question is …
How do these prices change in the market?
Being a trader, one should have a fair idea how prices change in market because this small info will be helpful to you later.
We live in an Interconnected world where like you and me, there are millions of traders trading at every moment. There is a continuous buying and selling going on.
More than that there are Super Banks, Large commercial companies, Governments who are trading here and there with other countries. Also the banks which are continuously adjusting the rhythm of supply and demand. Altogether they are responsible for changing the prices in the market.
How do read a Forex Quote?
You must have seen the forex pairs are written like this … GBP/USD , EUR/USD , USD/CAD etc.
They reason they are quoted in pairs is because in every foreign exchange transaction, you are BUYING one currency and SELLING another.
Let’s go back to our above airport example …
We talked about two currencies USD and JPY where 1 USD was equal to 100 JPY.
In forex they are quoted this way USD/JPY = 100
First currency written in Forex Pair is Base Currency, while the second currency is the Quote Currency. The base currency is the “basis” for the buy or the sell. If you buy USD/JPY this simply means that you are buying the base currency and simultaneously selling the quote currency. In caveman talk, “Buy USD , sell JPY”.
If the Dollar rises against the Yen, then a single Dollar will be worth more Yens and the pair’s price will increase. If it drops, the pair’s price will decrease.
So if you think that the base currency in a pair is likely to strengthen against the quote currency, you can buy the pair (going long). If you think it will weaken, you can sell the pair (going short).
Timings of Forex Market
The market rarely closes! It’s open virtually round the clock.
The forex market is open 24 hours a day and 5 days a week, only closing down during the weekend.
So unlike the stock or bond markets, the forex market does NOT close at the end of each business day.
Instead, trading just shifts to different financial centers around the world.
The day starts when traders wake up in Auckland/Wellington, then moves to Sydney, Singapore, Hong Kong, Tokyo, Frankfurt, London, and finally, New York, before trading starts all over again in New Zealand!