What is Forex?

When traveling to another country, you will often find places to exchange your currency at the airport. You will be able to exchange your current currency to the currency of the country which you are visiting.

To exchange your current money, you will need to find a currency exchange counter. These counters usually have screens displaying the different, up-to-date, exchange rates for all the major currencies. Depending on the currency exchange rate of the day, will depend on how much you own money’s worth in the new country you are visiting.

By your exchanging your currency to the new currency, you have, simply put, participated in the forex market. When put into forex trading terms, you sold currency X and bought currency Y. For example, if you are visiting the United Kingdom from the United States, you have sold your dollars and bought pounds.

On your way back you, you will want to exchange back to your home currency. However, you may not get back the same value to which you originally bought. The exchange rates are always changing. It is the constant changes in the exchange rates that give people the opportunity to make money in the foreign exchange market.

The foreign exchange market is the world’s largest financial market. It is also just known as “forex” or “FX.” The foreign exchange market has a daily trade volume of $5.3 trillion. This shadows other financial markets in comparison.

Let’s put the enormity of the foreign exchange market into perspective.

The New York Stock Exchange trades about $22.4 billion each day. This makes it the largest stock market in the world.

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The New York Stock Exchange (NYSE) is front and center of the daily news. From the daily news to financial report, you will hear about the NYSE. You will hear people talking about the “market.” When people say this, what  they usually mean the stock market. The NYSE to an outsider may seem like the big, strong, fearless leader of the stock market.

However, if you take a step back, and you get a clearer perspective of the picture.

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In comparison to the foreign exchange market, the NYSE looks small and weak. It doesn’t seem like the NYSE stands a chance against the Foreign Exchange market.

The graph below makes things look even clearer and easier to understand. This chart displays the average daily trading volume for the foreign exchange market, the New York Stock Exchange, the Tokyo Stock Exchange, and the London Stock Exchange:

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Looking at this graph, it becomes apparent that the forex market is over 200 times bigger than all the other markets examined.

However, it’s not as simple as it seems.

The $5 trillion worth of the Forex market is the entire global foreign exchange market. People who only exchange currencies when traveling, as mentioned above, are known as retail traders. Retail traders trade on the spot market, which is worth about $1.49 trillion. So, even though the forex market may seem huge, it is not as big as it’s made out to be.

This is just the beginning when it comes to the foreign exchange market. There is more to know and learn. The next section will explain to you what exactly gets traded and exchanged in the foreign exchange market.

What is Forex: What is Traded in Forex?

In what form is foreign exchange done? Money! 

Though this answer may seem simple, it can be confusing, because you do not receive any physical evidence in your hands of what you have purchased.

To help you understand, when you buy a currency when visiting a country, it is as if you are buying stocks in a company. The amount you receive in exchange for your purchase will depend directly on what the market’s opinion and standing are of the economy and future of the country.

For example, when you buy a currency, like British pounds, you are purchasing a “share” in the British economy. You are taking a chance and betting that the British economy is doing well, and you are betting that it will also get better with time, increasing the value of your money. When the time comes for you to sell your “shares” back, you hope that your chance paid off and that you will end up with a profit, because the British economy improved.

Essentially, the rate of exchange of one currency versus that of another currency is a reflection of the state of that country’s economy, in comparison to the economies of other countries.

Once you have finished reading this article, you will have a clear understanding as to what forex is, and you will want to start buying and selling currencies yourself.

Major Currencies

Symbol Country Currency Nickname
USD United States Dollar Buck
EUR Euro-zone members Euro Fiber
JPY Japan Yen Yen
GBP Great Britain Pound Cable
CHF Switzerland Franc Swissy
CAD Canada Dollar Loonie
AUD Australia Dollar Aussie
NZD New Zealand Dollar Kiwi

The symbols for each different currency have three letters. The first two letters are the abbreviation of the country’s name, and the third letter is what identifies the country’s currency name.

It is relatively straightforward. Looking at an example from the table above, JPY can be broken down into JP which stands for Japan and Y which is the Japanese currency, Yen.

The currencies which are listed in the above table are known as the “majors.” This is because these currencies are the ones which are the most widely traded around the global foreign exchange market.

Something to take note of is, that the nicknames for each currency are not fixed. Some of the nicknames can be for other currencies as well. As well as, there are also many other nicknames which have not been noted. Depending on your country of origin, you may have different nicknames for your currency and money. Depending on the circumstance, they can be used interchangeably. Some countries may base the nickname for their currency on the person whose face is printed on the bill itself.

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What is Forex: Currency Pairs - Buying And Selling

The foreign exchange market is the buying of one currency and selling of another currency at the same time. The actions of buying and selling are simultaneous to each other. A broker or dealer does the action of trading the currencies. The currencies are traded in pairs. An example of currency pairs can be the United States dollar (USD) and the European Euro (EUR.) This pair can be written down as USD/EUR.

All trading on the foreign exchange market is done in currency pairs, which you buy or sell.

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Think of a contest of strength, a “tug of war,” between each currency. The force of pull a currency has on their side of the contest will depend on what the exchange rate is based at the time of trading. The rates of exchange constantly fluctuate, each side pulling at each other.

Major Currency Pairs

The table below listed what are known to be the “majors” of currency pairs. Because the dollar is widely used around the world, each currency pair is comprised of the dollar and another frequently traded currency. These “major” pairs are the most widely traded currency pairs which are traded across the globe.

Currency Pair Countries Forex Geek Speak
EUR/USD Euro zone / United States “euro dollar”
USD/JPY United States / Japan “dollar yen”
GBP/USD United Kingdom / United States “pound dollar”
USD/CHF United States/ Switzerland “dollar swissy”
USD/CAD United States / Canada “dollar loonie”
AUD/USD Australia / United States “aussie dollar”
NZD/USD New Zealand / United States “kiwi dollar”

The Major Cross-Currency Pairs (or Minor Currency Pairs)

Cross-currency pairs are pairs of currency which do not contain the U.S. dollar (USD). They are just known as “crosses.” The major crosses can also be known as “minors.” The cross-currencies which are the most widely and actively traded that are derived from the three major non-USD currencies are EUR, JPY, and GBP.

Euro Crosses

Currency Pair Countries Forex Geek Speak
EUR/CHF Euro zone / Switzerland “euro swissy”
EUR/GBP Euro zone / United Kingdom “euro pound”
EUR/CAD Euro zone / Canada “euro loonie”
EUR/AUD Euro zone / Australia “euro aussie”
EUR/NZD Euro zone / New Zealand “euro kiwi”

Yen Crosses

Currency Pair Countries Forex Geek Speak
EUR/JPY Euro zone / Japan “euro yen” or “yuppy”
GBP/JPY United Kingdom / Japan “pound yen” or “guppy”
CHF/JPY Switzerland / Japan “swissy yen”
CAD/JPY Canada / Japan “loonie yen”
AUD/JPY Australia / Japan “aussie yen”
NZD/JPY New Zealand / Japan “kiwi yen”

Pound Crosses

Currency Pair Countries Forex Geek Speak
GBP/CHF United Kingdom / Switzerland “pound swissy”
GBP/AUD United Kingdom / Australia “pound aussie”
GBP/CAD United Kingdom / Canada “pound loonie”
GBP/NZD United Kingdom / New Zealand “pound kiwi”

Other Crosses

Currency Pair Countries Forex Geek Speak
AUD/CHF Australia / Switzerland “aussie swissy”
AUD/CAD Australia / Canada “aussie loonie”
AUD/NZD Australia / New Zealand “aussie kiwi”
CAD/CHF Canada / Switzerland “loonie swissy”
NZD/CHF New Zealand / Switzerland “kiwi swissy”
NZD/CAD New Zealand / Canada “kiwi loonie”

Exotic Currency Pairs

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Exotic currency pairs can be explained as composition between one major currency with the currency of an emerging economy, such as Denmark, Singapore, or Brazil. The table below shows a few different examples of exotic currency pairs.

It is worth your while to know and be familiar with the different exotic currency pairs listed in the table. Your foreign exchange broker may find that they could be beneficial for you. However, because these pairs are not as heavily and widely traded as the “majors” or “crosses” may be, the transaction costs which are associated with trading these exotic currency pairs is usually bigger.

Currency Pair Countries Forex Geek Speak
USD/HKD United States / Hong Kong
USD/SGD United States / Singapore
USD/ZAR United States / South Africa “dollar rand”
USD/THB United States / Thailand “dollar baht”
USD/MXN United States / Mexico “dollar peso”
USD/DKK United States / Denmark “dollar krone”
USD/SEK United States / Sweden
USD/NOK United States / Norway

You will need to factor into your decision when wanting to trade exotic currency pairs, which it isn’t unusual to see spreads which are two or three times bigger that the majors, like EUR/USD or USD/CHF.

What is Forex: Liquidity and Market Size

In contrast to financial markets like the New York Stock Exchange, the foreign exchange market does not have a physical location nor does it have a central exchange point where trading occurs.

The foreign exchange market is known as an Over-the-Counter (OTC), or “Interbank” market. This is because the whole of the forex market is run electronically. It is led by a network of banks, running continuously over a 24-hour period.

Because the foreign exchange market is OTC, it is a spot forex market. This means that the forex market is spread all over the globe. There is no central location. You can trade anywhere in the world.

The forex OTC market is the most popular and vast of all the world’s financial markets. It is traded globally by the largest number of individuals and companies.

Participants in the foreign exchange OTC market choose with whom they want to trade. Their decision is dependent on the trading conditions, the attractiveness of prices, and reputation of the trading counterpart.

The graph below shows the seven most widely traded global currencies.

The currency that is traded the most is the dollar. It takes up 84.9% of all the forex transactions. The second on the list is the euro’s share which is ar 39.1%. Following these two is the yen at third place. The yen trades at 19.0%. What is apparent from this table is that the major currencies control the top spots on the list.

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*Since there are two currencies involved in each transaction, the value of the percentage shares of individual currencies, which are calculated, totals 200% instead of 100%

From this table, it is clear that the USD is the most frequently traded in the foreign exchange market.

The Dollar is the Master of the Forex Market

The reason why the U.S. dollar (USD) is the most mentioned of all the currencies is that the USD is one-half of all the major currency pairs. The major currency pairs make up 75% of all the trades which occur.  

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The International Monetary Fund (IMF) notes that the U.S. dollar comprises of approximately 62% of the world’s official foreign exchange reserves. The reason for this large percentage is because almost all businesses, central banks, and investors own it, so they pay careful attention to the U.S. dollar.

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This is not the only reason; there are some other significant reasons as to why the USD have such a central and leading role in the foreign exchange market:

  • The economy of the United States is the world’s BIGGEST economy
  • The world’s reserve currency is the United States dollar
  • The largest and most liquid financial market in the world is the U.S. market
  • The political system of the United States is extremely durable
  • The world’s foremost military superpower belongs to the United States
  • Many cross-border exchanges are conducted in U.S. dollar. An example is gold which is priced in U.S. dollar. So if the Switzerland wants to buy gold from South Africa, the medium which the transaction is conducted in is the U.S. dollar. If Switzerland does not own any dollars, it would have to sell its francs and then buy U.S. dollars.

Speculation in Forex

Most currency trading is based on speculation, even though part of the trading volume of the foreign exchange market is commercial and financial transactions.

This means that most of the trading volume comes from the traders who buy and sell. The interactions are based on intraday price movements.

Speculation done by the traders is thought to have a volume estimated at 90%

The measure of the foreign exchange market signifies that its liquidity is extremely high. This liquidity is the volume of buying and selling which is happening at any given time.

Therefore it becomes easy for anyone to buy and sell currencies.

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This liquidity from the investors is necessary and what determines how quickly the price can change during a particular period. A forex market which is liquid allows for huge volumes of trading to take place with very little effect on the rate, or the action of the action.

The forex market may be relatively liquid, the depth of the market constantly changes, all depending on what the currency pair is and the time of day.

The forex trading lessons will explain to you how the timing of your trades can affect the currency pair which you are trading.

There are a few tricks which help you when you trade.

What is Forex: The Many Ways to Trade Forex

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There are some different ways that traders have thought of, to help you to trade, invest or speculate in different currencies. Some of the most popular methods include forex spot, futures, options, and exchange-traded funds (ETFs).


Spot Market

Currencies are traded immediately in the spot market. They are traded on the spot, making use of the current, up-to-date market price. The advantages of the spot market are its simplicity, liquidity, tight spreads, and round-the-clock operations. It is relatively straightforward to take part in the spot market as you only need $25 to open an account to begin trading. The brokers on the spot market also supply charts and research free of charge.

Futures

Futures can be explained as the contracts which allow you to buy or sell a specified asset. This action can be done at a specified price on a future date. This is where they get the name “futures.” The foreign exchange futures were created by the Chicago Mercantile Exchange (CME) IN 1972. Future contracts, since then, have become standardized and are traded through a centralized exchange system. The futures market is very transparent and well-regulated. Due to this fact, the price and transaction information are readily available.

Options

The financial tool which gives the buyer the right or the option is called a öption.” this is not an obligation, but an option to buy or sell at a specified price on the date of expiration of the option. If an option were “sold” by trade, the trader would be obliged to buy or sell an asset at the expiration date for a particular price. Options, like futures, are traded on an exchange market. Some exchange markets are the Chicago Board Options Exchange, the International Securities Exchange, and the Philadelphia Stock Exchange. The disadvantage to options traded in the foreign exchange market is that the for central options the hours are limited. Also, the liquidity if not as ideal for options as with futures or the spot market.

Exchange-trade Funds

The youngest member of the foreign exchange world is exchange-traded funds (ETFs). Exchange-traded funds contain collection stocks which are combined with some currencies. This allows the trader to expand and diversify with different types of assets. These ETFs are created by financial institutions. They can be traded like stocks on an exchange. The limitations of exchange-trade funds are that the market is not open 24 hours. This is similar to foreign exchange options. Also, since ETFs contain stocks, they are subject to transaction costs and trading commissions.

6 Critical Things to Consider When Choosing a Broker

These days there’s so much competition in the retail forex market as well as so many brokers to choose from.  Rather than becoming bewildered when navigating through all the brokers available, you should look for these 6 essential qualities in a broker.

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1. Security

The utmost importance is that your broker have high level of security, especially since you will be giving them control of your money. For your safety, you should ensure that your broker is both legitimate and credible.

Below is a list of countries with their corresponding regulatory bodies:

  • United States: National Futures Association (NFA) and Commodity Futures Trading Commission (CFTC)
  • United Kingdom: Financial Conduct Authority (FCA) and Prudential Regulation Authority (PRA)
  • Australia: Australian Securities and Investment Commission (ASIC)
  • Switzerland: Swiss Federal Banking Commission (SFBC)
  • Germany: Bundesanstalt für Finanzdienstleistungsaufsicht (BaFIN)
  • France: Autorité des Marchés Financiers (AMF)
  • Canada:  Autorité des Marchés Financiers (AMF)

Before you work with any broker, you should make sure that your broker is a member of one of the regulatory bodies mentioned above.

2. Transaction Cost

Regardless of what you do, there will ultimately be transaction costs. Naturally, you will try to find the best deal with the most affordable rates (commissions or forex spreads). However, sometimes you get what you pay for.

By paying a lower transaction fee, you may obtain a less than reliable broker. It is pivotal to find the equilibrium between the prices you are willing to pay and the quality you deserve.

3. Deposit and Withdrawal

A good broker should allow you to efficiently and comfortably deposit funds and withdraw your earnings whenever you feel like it. There should be no motivation for them to deny you access to your profits unless they need your funds to facilitate more trades.

4. Trading Platform

In the online forex environment, trading occurs through the brokers’ trading systems. So make sure to test out what platform the broker has to offer. As a user it should be comprehensible, user friendly and easily navigable.

Some even offer unique tools to make your trading that much simpler.  

5. Execution

Your broker should be looking out for your best interests. Consequently, they should be filing your orders at the best prices. This means you should be selling and buying as close to market price as possible.

If you click buy for a certain trade, you should almost instantaneously get filed at that price or within micro pips. This slight pips difference in price can make winning that specific trade quite difficult.

6. Customer Service

Brokers should be there helping with accounts and technical support when you need them the most. If something goes awry, it is fundamental that you can get in contact with them as soon as possible.

Some brokers may try to fool you into trusting them when you open an account, but when you need their support they are nowhere to be found. So be on the lookout for a trustworthy and truly helpful broker.

Forex Broker Types: Dealing Desk vs. No Dealing Desk

If you are in the market for a new broker, finding “the right one” can take you time and effort. Not all are created equal, and you need to know which compliments your needs and makes your banking more efficient.

There are so many varieties of brokers to choose from; each has certain advantages that might make one a better fit for you and your lifestyle. The two main types of brokers are Dealing Desks (DD) and No Dealing Desk (NDD). Dealing Desk (DD) are also known as Market Makers. On the other hand, No Dealing Desks are divided into Straight Through Processing (STP) and Electronic Communication Network + Straight Through Processing (ECN+STP).

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What is a Dealing Desk Forex Broker?

A Dealing Desk (DD) brokers, also known as Market Makers, make money through spreads and arranging liquidity to their clients. These Market Makers precisely develop a market for their customers, or they take the other side of a client’s trade.

However, there’s no need to to be concerned about there being a conflict of interest. Since they supply and file both the buy and sell quotes for their clientele, they are disinterested on each trader’s individual decision.

Likewise, clients of dealing desk brokers are not able to see the real interbank market rates. However, the competition among brokers is so rigid that Dealing Desks brokers offer similar rates, if not the same, to the interbank rates. The diagram below demonstrates how trading with a Dealing Desk broker works:

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Let’s simplify it further. For example, you have decided to buy an order for EUR or USD for 100,00 with your DD broker.  First, your broker will try to match your order with a similar previous order or pass your trades on their liquidity provider. These providers are able to easily buy or sell a financial asset.

In doing so, they minimize the risks, while earning from the spread without taking from the other side of your trade.  Nonetheless, different brokers take different risk management policies so you should discuss these details with your own broker.

What is a No Dealing Desk Forex Broker?

In contrast,  the no dealing desk (NDD) brokers do not transfer their consumers orders through a Dealing Desk.  environment. No Dealing Desk brokers can either be STP or STP+ECN.

In the no dealing desk environment, brokers automatically matches orders, or takes the other side. Normally this is completely computer driven, and instantaneous. This is one of the main advantages over the traditional dealing desk model. Usually, they charge a small commision or slightly markup the spread.

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What is a STP Broker?

Forex brokers that have an STP system route the orders of their clients directly to their liquidity providers who have access to the interbank market. NDD STP brokers usually have a variety of liquidity providers, and each provider has its own bid and ask price.

Let’s clear up how brokers and liquidity providers work, by using this example. Your NDD STP broker has three different pairs of bid and ask quotes from three different liquidity providers.

Bid Ask
Liquidity Provider A 1.2996 1.2999
Liquidity Provider B 1.2997 1.2999
Liquidity Provider C 1.2998 1.3000

Looking at these quotes provided, the bid/ask is currently 1.2988/1.3000. However, this won’t be the quote you see in your side. Your broker worked tediously and strenuously to sort through the quotes and find the best rates for you. As compensation for their work,  your broker adds a small, usually fixed, markup.

As a result of the changing bid and ask quotes, most STP brokers have variable spreads, a few do offer fixed spreads. So, if the liquidity providers widen the range of their spreads, the brokers have to likewise widen their spreads.  

What is a ECN Broker?

On the contrary, True ECN brokers allow their clients orders to interact with the orders of other participants in the ECN. These possible participants could be banks, hedge funds, retail traders, or other brokers. Therefore, these participants are constantly proposing the best bids and ask prices.

ECN usually get paid through a small commission rather than a fixed mark up.  

Dealing Desk vs. No Dealing Desk

Picking a broker may seem like a simple task, but it’s not. Chose the wrong one, and you’ll lose valuable time and tarnish your profits. Alternatively, if you put a little diligence into selecting the right one, you can ensure your trades will reach their full potential, and your time in the market minimized. Here’s a rundown of the major differences between Market Makers, STP brokers, and STP+ECN brokers:

Dealing Desk (Market Maker) No Dealing Desk (STP) No Dealing Desk (STP+ECN)
Fixed Spreads Most have variable spreads Variable spreads or commission fees
Take the opposite side of your trade Simply a bridge between client and liquidity provider A bridge between client and liquidity provider and other participants
Artificial quotes Prices come from liquidity providers Prices come from liquidity providers and other ECN participants
Orders are filled by broker on a discretionary basis Automatic execution, no re-quotes Automatic, no re-quotes
Displays the Depth of Market (DOM) or liquidity information

Forex brokers want their clients to keep trading and doing business with them, not for you to stop trading. If all their customers lost all their money in trading, they would not have any customers left.

The optimal client/broker relationship is one where the client more or less breaks even.