What is Forex?
Foreign exchange (commonly known as Forex or FX) is the world’s premier financial market. Worth trillions of dollars per day, it is essentially the process of simultaneously buying once currency and selling another.
In order to make a profit, an investor must correctly anticipate which way a currency price will change. Markets open Monday morning in Australia and close Friday evening in the US, presenting traders with 24/5 investment opportunities.
In Forex, currencies are quoted in pairs, essentially pitting one against the other. They consist of a base (displayed first) and a counter currency (displayed second), and a trader must decide how the base will perform against its counterpart.
Each currency is displayed as a three-letter symbol that is usually derived from its home country and the name of the national tender. For example, Australian Dollar is AUD and Great British Pound is GBP. The Euro (EUR) is the only exception to this rule, since the Eurozone is made up of a group of countries.
Currencies are divided into two categories. Major currencies come from stronger world economies, such as the Eurozone, UK and USA.
There are three types of currency pairs – major, minor and exotic.
Major pairs will always contain the USD, either as a base or counter currency. Examples include USD/AUD, GBP/USD or USD/JPY.
Minor pairs are cases when major currencies are traded against each other, but the USD is not one of them. Examples include GBP/JPY, EUR/GBP and NZD/CHF. Meanwhile, exotic pairs involve one major and one minor currency – such as CHF/TRY or GBP/NOK.
How to make a profit
When placing a trade, investors must decide whether the base currency will perform better (appreciate in value) than its counterpart, or if the opposite will happen. If they think the base currency will fare better, they will “buy” (or take a long position) a currency pair, or they will “sell” a pair (or take a short position) if they believe the counter currency will be stronger.
If the market responds the way they predicted, the investor will make a profit on their trade. However, if their assumption is incorrect – they will start to make a loss.
Factors affecting prices
There are many things that can change currency prices. These can be political events such as general elections, economic factors like recessions, or even national disasters.
Financial institutions and politicians can also have an impact when they discuss monetary policy. Dovish (negative) statements can send a currency lower, while hawkish (positive) sentiments will have the opposite effect.