For this first article we've chosen a Q&A style, because it enables us to easily and quickly explain you some of the fundamentals.
What is Forex?
Forex stands for Foreign Exchange, AKA the currency market. The Forex market is completely virtual. There is no Forex Building where screaming 23year olds try to sell Dollars or Euro's, it's all done digital and without a central overseeing authority.
Who does the trading?
Mostly banks. Multinationals and governments also act on the forex market, but for different reasons. Multinationals need the forex market because they have business activities around the world. Governments sometimes step into the forex market because they feel their currency is under- or overvalued. Through intervention (buying or selling their currency) they try to change the value of their currency.
But it's the banks that really propel the forex markets. They buy/sell for: a) clients that need to buy/sell currency to do business in a country b)clients that speculate - for instance brokers that have clients like you and us c)themselves, in other words, for their own speculative acitivities.
Why is there something like Forex?
Because the values of currencies change. Their value changes both when compared to themselves -for instance, a dollar in 2008 isn't worth what it was in 1985- as well as compared to other currencies.
That last part (the value of a currency compared to other currencies) is crucial in the forex market, because currencies are always traded in pairs. For instance, the EUR/USD pair.
Why does the value of a currency change, when it's compared to other currencies?
Well suppose it wouldn't. Suppose the value of the USD (US dollar) compared to the Euro would be fixed, so the price would always be the same. Let's say 1 Euro is worth 1,20 Dollar no matter what. Now suppose the US economy goes into a deep recession, that only mildy affects the Euro zone. Investors are massively pulling out of the American markets and start investing a good portion of those monies in Europe. However, before they can do so, they first have to sell their dollar denominated assets (stocks, real estate, bonds etc, all priced in dollars) in order to buy assets in the Eurozone, for which they have to pay in Euro's. So everybody is offering dollars that nobody wants in order to buy Euro's that everybody wants. In a normal market, would the price remain the same under such circumstances?
An easy way of understanding all this is to view a country as a company and it's currency as stock. On the stock market, all companies compete for the same investment monies. If a company does well, people want to invest more in it, but if it doesn't, investors sell their stock.
So, if the US economy performs well compared to other economies, people want to buy dollars so they can invest in the US economy (buy stocks, bonds, companies). If at the same time the Britisch economy does not do so well, investors will sell their Pounds (GBP, also known as the Sterling, the Cable) so they can buy dollars. Therefore, the pair GBP/USD will trade down.
How are currencies traded?
As said, all currencies are traded in pairs, to be able to compare them to other currencies. There are hundreds of pairs traded on the market (as there are hundreds of currencies) but most brokers offer 10 or 15 of the most traded pairs. The 5 most traded pairs are known as 'The Majors'. They are, in order of importance:
EUR/USDaka Euro/USdollar
USD/JPYaka USdollar/Japanese Yen
GBP/USDaka British Pound/USdollar
USD/CHFaka USdollar/Swiss Franc
USD/CADaka USdollar/Canadian Dollar
If you look at the homepage of
Forexacademy you can see the real time 'quotes' (their value) for these pairs. The value is printed with 4 digitals. So for instance, if the EUR/USD is at 1.4580, it simply means that 1 EURO is worth $1.4580.
But you can't trade just 1 Euro on the forex market. The primary form is a standard contract. This stands for 100,000 units. However, most platforms also offers mini contracts, worth 10,000 units.
Can you give an example of trading a currency?
Later on, we'll explain in detail how you can trade your own positions (open and close a currency trade), but for now, lets just look at what it means to buy 1 mini contract EUR/USD.
The beauty of it all is that you don't need $10,000 to buy or sell 1 mini contract of EUR/USD that is worth $10,000. The only money you need is that which you are willing to risk on this 1 contract. The money then, that you can win or loose, comes from the rise or fall in value of the currency you bought.
Remember a forex quote has 4 digits after the dot? Well the fourth and last of those is the worth of 1 pip. A pip (also 'point') is the smallest unit of price for any foreign currency, i.e 0.0001. Right now you might think: 'pip, quote, point, what is al this mumbo jumbo!?' But believe us, within 2 weeks you'll be posting in our forexacademy forum how many pips you've made on this or that trade. :)
So in the EUR/USD, 1 pip is worth 0.0001 dollar. If you speculate on the rise of the EURO against the Dollar, you buy 1 mini contract and the price then goes from 1,4580 to 1,4585, you have made 5 pips. Which, in a mini contract, stands for $5. (in a standard contract, 1 pip is worth $10)
We're almost absolutely sure that if you'd never heard of forex up untill now, your head hurts because of all this new information. Yes it's tough in the beginning, like we remember it was tough figuring out strategy games like Civilization and Starcraft. But the big difference with those games is that this game can come with 6 zero's..... So hang in there and soon you can start playing this game, where you don't earn points, or stars, or virtual golden nuggets if you're good at it, but real, cold, hard cash.
