What is forex?
Forex is the foreign exchange marketplace where currencies from
different countries are valued and exchanged. Most people only know
about forex to the extent that they have changed money going from one
country to another. When they did so, they unwittingly played a role in the
world’s biggest marketplace. Forex trades almost $2 trillion per day, a
total that exceeds all of the world’s biggest – and better known – markets.
Since currencies are valued differently, there is a market in place to set
those values. Where a market exists speculation inevitably follows. In this
case, the market is hyperactive. Banks sending deposits around the
world, corporations hedging their exposure to currency risk in different
countries, government banks forwarding national economic goals through
monetary policy, and massive investment funds playing the role of
a speculator. Not long ago, that was the extent of the market. It was the
domain of the professional trader or banker.
The word “market” usually invokes the idea of a central market place like
the New York or London exchanges. This is not the case in forex. Instead,
forex functions through what is known as the “interbank” market.
Interbank is a fancy way of saying that banks trade with each other, absent
a central market place. This is one major reason why volume data is not
available for forex. It’s also the reason why retail investors and smaller
traders were left on the sideline for so long.
In the 90’s, a series of events unfolded that made forex available to retail
investors. Deregulation led many companies to form pools of liquidity
where retail investors could take advantage of the huge speculative
opportunity in forex. These dealers offered high leverage, low minimums,
and a new way to trade
What are pairs and pips?
Each currency exists in the marketplace not on its own, but as a “cross”
between itself and another currency. This is practical since when you
travel to Europe you want to exchange your money for Euros. If you have
US Dollars, you will be exchanging money at the rate set by EURUSD.
EURUSD is a “pair”. It also happens to be the most popular pair. Most
currencies are paired with EUR and USD, and to other currencies to a
lesser extent. The “four majors” are EURUSD (Euro/Dollar), USDJPY
(Dollar/Yen), GBPUSD (Pound/Dollar), and USDCHF (Dollar/Franc).
The bid-ask spread is usually lowest for the four majors since their
volume is the highest. With high volume, the dealer is usually assured of
having ample liquidity to meet your trading needs, so they charge you less
through the spread. For more obscure, less traded pairs, the spread will be
more, since dealers assume more risk in completing those transactions.
The spread itself is made up of pips. A pip is simply an incremental unit in
forex. In stocks, you call them ticks or points. That makes sense because
usually all stocks are quoted in the same currency. In forex, each currency
may have a different incremental unit. For example, a quote in EURUSD
might be 1.3240, versus a quote in USDJPY at 107.87. What is the
incremental unit? There is no common unit, so one was created, and it
was named a pip. A pip is always worth $10 if the pair ends in USD. If
not, you will need to refer to a pip calculator to get the value, since these
per pip values can vary, even within the same currency.
How do you trade forex?
There are two major methods for trading forex: fundamental and
Fundamental analysis relies upon a broad and near-expert understanding
of multi-national macroeconomic statistics and events.
Fundamental traders believe that the value of a pair is determined by the
underlying health of the two nations involved in the pair. A high value for
GBPUSD, for example, would suggest a better economic outlook in Britain
vis-à-vis the United States. Global events like news, catastrophes, politics
or economic shocks all play a role in determining a price.
Technical analysis is based on the mathematical analysis of price, and of
many variables which all derive from a price. Technical traders believe that
technical indicators include fundamental analysis and also provide