What Is Trading?
Currency trading is the most liquid and robust market in the world. No other market can compare to the sheer value of this massively traded market. The forex or foreign exchange market is a global decentralized market for the trading of currencies.
When trading currency pairs, you’re effectively buying one currency and selling the other currency. Let’s take a simple example to illustrate how this works: the EUR/USD is a commonly traded currency pair. The EUR is the symbol for the Euro and the USD is the symbol for the US Dollar. In the above currency pair, the EUR is referred to as the base currency and the USD is referred to as the quote currency. The ratio is viewed as a single unit, even though it refers to 2 individual currencies. In other words, you trade the EUR/USD as a currency pair – not the EUR or the USD.
For example, a quote of EUR/USD of 1.10 means that 1 euro buys 1.10 U.S. dollars. A rise of the quote of EUR/USD to 1.20, means that now 1 euro buys 1.20 U.S. dollars. In this situation, the euro became stronger and the dollar weaker. The goal of a forex trader is to anticipate the rise or fall of a currency’s value, in order to buy or sell that currency.
Major World Currency Pairs
Many currencies being used around the world, but just a few are considered “major” currencies which when combined form the “major” pairs. There are six most-traded forex pairs in the market, these include:
- EUR/USD: The euro and the U.S. dollar.
- USD/JPY: The U.S. dollar and the Japanese yen.
- GBP/USD: The British pound sterling and the U.S. dollar.
- USD/CHF: The U.S. dollar and the Swiss franc.
As you can see, all currencies listed above are used in developed economies, as they make up the highest share of the world trade, which makes these currencies the most traded in the world.
Minor and Exotic Pairs
Minor Pairs are those currency pairs that are less traded than major currency pairs. They are also less liquid than and they often have wider spreads. As a general rule, minor currency pairs are any pairs other than the six major currency pairs listed above. Exotic currency pairs typically include a currency from an emerging market country. The reason that they are called exotic currency pairs has nothing to do with the location of the country, but rather the additional challenges involved in trading these currency pairs. Just like minor pairs, exotic currency pairs also feature wider spreads and fewer market-makers.
Currency Value Fluctuations
Usually, currency pairs don’t fluctuate that much. Most pairs will move less than 1% daily, making forex one of the least volatile financial markets. Liquidity in the forex market however is extremely deep, so if you decide to buy or sell currency, it will take you milliseconds to do so. That’s why a relatively high leverage ratio is made available when trading forex. Leverage can increase the value of potential gains from small movements but also increase the risk of higher losses.
What Moves a Currency?
Currency values can change quickly and for many reasons. Sometimes it’s a reaction to external political and economic news, such as Great Britain’s exit from the European Union. Other times, the market itself drives value changes. Oftentimes, both external and internal events can drive currency value changes and it’s a trader’s ability to accurately forecast those changes that can create profits or losses.
A currency pair is mathematically a division or a fraction. We describe the pair EUR/USD, as Euro divided by US Dollar. Positive news about the Euro, for example, unexpectedly high inflation in Europe, would raise the value of the Euro.
On the other hand, positive news for the US dollar would raise the value of the USD. As the second currency in the currency pair, this would lead to negative performance in the EUR/USD rate.
Other factors like interest rates, new economic data from the largest countries, and geopolitical tensions, are just a few of the events that may affect currency prices.
Why you should pay attention to the time?
In general, currencies are traded 24 hours a day, but not every currency is always traded in the same volume. Traders around the globe tend to trade in their local/national currency as these are the most familiar to them and they have a certain affinity for it. For this reason, a Japanese trader would most likely prefer a currency pair that contains the JPY (Japanese Yen), whereas an American would tend towards pairs that contain the USD (US Dollar). This favoritism can also be seen as a time factor, as local currencies are more highly traded during standard trading hours.
Other traders can use this knowledge to their advantage and looks for currency pairs that are NOT affected by this time factor. Currency pairs that are only being influenced make it easier to speculate on their direction because you will only need to factor in what can be affecting one of the currencies in the pair.
Understanding the risks
Finally, it cannot be stressed enough that trading foreign exchange on margin carries a high level of risk, and may not be suitable for everyone. Before deciding to trade foreign exchange or any other CFD product you should carefully consider your investment objectives, level of experience, and risk appetite.