Okay, so now that we’ve had an introduction to the Forex market and understand what it is, it’s time to delve a little bit further and take a look at what is traded on this market. In the introduction we learned that Forex is the foreign exchange market.
So, what’s traded on this massive market? In a nutshell, money. It’s that simple and that complicated. The foreign exchange market can sometimes be confusing to some people because you are not actually purchasing anything tangible. In many ways, when you buy currency, you are buying a share in a certain country. It’s a lot like when you purchase stocks of a particular company. Prices for currencies are always a reflection upon the economy of a country represented by its currency.
This means that you are really buying a share of that country’s economy when you invest in its currency. Of course, the hope is that the economy is doing well and that it will perform even better in the future. In other words, you’re hoping that when you decide to sell your currency that the price will be higher than when you initially bought; allowing you to earn a profit.
As you may already know, every country has its own currency. You might already be familiar with some of the major currencies around the world:
- United States-Dollar
- Euro zone members-Euro
- Great Britain-Pound
- New Zealand-Dollar
Now, as you probably noticed, some countries share the same name for their currencies. That doesn’t mean that those currencies are the same or even that their exchange rates are the same.
Trading in Pairs
Forex trading is conducted by purchasing one currency and selling another currency. As a result, you always trade in pairs and all purchases are made through a dealer or a broker. For example, you might sell U.S. dollars and purchase Japanese Yen or sell Japanese Yen and purchase the British pound. Just as there are several major currencies throughout the world, as listed above, there are also several major currency pairs. These are the pairs that are most often traded. The reason for this is that these pairs are generally the most liquid.
All right, so now that we understand that currencies are traded in pairs and are frequently traded in common pairs, we need to look at a few exceptions. For example, when one part of a currency pair is not the U.S. dollar, that pair is known as a cross-currency pair. Sometimes, it is abbreviated just as ‘crosses.’ Major crosses are also often known as minors. There are three major non-USD currencies. They are:
- Japanese Yen
- Great Britain Pound
Who is Involved in the Forex Market?
At this time it is a good idea to take a quick look at who is involved in comprising the basic structure of the Forex market. In order to best understand this market, you need to have an understanding of the primary players. Up until fairly recently, at least until the late 1990s, the only people involved in this type of trading were essentially the big guys. This is because the initial trading requirements were so high. It was not uncommon for you to need at least a few million dollars. That type of entry requirement would quickly eliminate most of us!
This is because when it was first instituted Forex was only intended to be used by large institutions and banks. The Internet changed all of that. It’s now possible for even little guys like us to get involved.
So, let’s take a look at who the primary players in this market are. They include:
- Super banks
- Large commercial companies
- Central banks and governments
The Forex spot market is actually decentralized. As a result, exchange rates are determined by the larger banks in the world. It is these banks, which are referred to as the interbank market, that comprise most of the Forex transactions in any given day. Some of these banks include Citigroup, Barclays Capital, UBS and Deutsche Bank. There are also companies that participate in this market as well simply for the purposes of conducting business.
Whenever there is a merger and acquisition between two large companies, the result can often be a fluctuation within currency exchange rates. Central banks and governments, including the Federal Reserve and the Bank of England are also frequently involved in this market as well. They are often involved in the Forex market for their day to day operations, much in the same way as large companies. Such basic operations might include making international trade payments. Central banks can also impact the Forex market by adjusting interest rates in order to control inflation.