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Understanding the Basics of the Foreign Exchange Market | Financial Planning Tips

Understanding the Basics of the Foreign Exchange Market

Understanding the Basics of the Foreign Exchange Market The foreign exchange market, better known by its popular acronym, forex, is the largest financial market in the world. It is through this market that the currencies of the world are valued (relative to one another) and exchanged. Providing income to millions of banks and individual investors around the world, forex trades approximately $1.5 trillion daily. That’s right, DAILY! To put that dollar amount into perspective, the more popular New York Stock Exchange trades a daily average of just under $20 billion daily, 75 times LESS than that of the foreign exchange market.

Forex and How it Modifies Exchange Rates

Currency trading takes place in pairs known as ‘Currency Pairs’. When a transaction is made one currency is sold and another is bought simultaneously. For instance, buying 10,000 Euro at 1.20 EUR/USD means that we have also sold $12,000 U.S. dollars. The current exchange rate of any currency pair is dependent on a myriad of variables; however, forces generated through supply and demand and the condition of the respective country’s economic health generally determine it. According to the team at http://www.topforexnews.com, there are several commonly exchanged currency pairs. They include:

EUR/USD          AUD/USD          GBP/USD

USD/JPY           EUR/JPY           EUR/GBP

USD/CAD          USD/CHF

Some are traded more frequently than others, but nonetheless, they are all important to any successful trader.

Reading an Exchange Rate

It may be a bit confusing glaring at a chart filled with numbers and signs, especially a long list of currency pairs that are constantly changing. It is important that you, the investor, understand how to read them. Thankfully, it’s actually quite simple: the first currency (i.e. EUR in EUR/USD) is known as the base currency and the second currency (i.e. USD in EUR/USD) is known as the quote currency. When an investor is looking to buy into a currency, the exchange rate tells how much of the quote currency is required to acquire one base currency. Similarly, an investor selling a currency sees from the exchange rate how much of the base currency he/she will receive for a single quote currency. For example, 1.2500 EUR/USD indicates that $1.25 U.S. Dollars must be paid to purchase one Euro dollar, and that $1.25 U.S. dollars would be received for each Euro dollar sold.

Making a Profit

Trading forex is extremely similar to trading in the stock market. Having any experience in the stock market gives any new investor a head start. The objective is to exchange one currency for another in the expectation that the price will change and the investor’s position will benefit. There are two positions that can be taken, a long position or a short position. A long position, also known as “going long”, means that a purchase of the base currency is made with the expectation that it will appreciate, at which point the investor would then sell the acquired base currency, exiting his/her position. A short position, or “going short”, means that a sale of the base currency is made with the expectation that it will depreciate, at which point the investor would then repurchase the base currency, reentering his/her position. Making a profit through forex is fairly simple and best described through example. An investor enters a long position in the EUR/USD currency pair investing $11,800.00 at a rate of 1.18. The transaction leaves the investor with 10,000 Euros. Two weeks later, the investor exchanges the 10,000 Euros back into U.S. dollars at the exchange rate of 1.2500. The investor now has a U.S. dollar amount of $12,500.00 and has made a profit of $700.00.

Conclusion: A Lot to be Learned, A Lot to be Earned

As the largest financial market in the world it is obvious that there is a lot of money to be earned in forex. Of course, these are only the basics of the basics. There is much more to learn and understand about forex and the implicate risks involved. It is very important to understand the high degree of risk trading forex poses to your capital. It is said that trading forex is no different from gambling unless you are very well educated on the subject and have a robust trading system. However, do not let this get you down. Practice makes perfect and one day you can be making a lot of money trading in this market. Good luck!


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