ForEx, as the name suggests is Foreign Exchange market. Forex market is the place where people buy and sell currencies. And there are three types of currency pairs- Major currency pairs, Minor currency pairs and Exotic currency pairs.
The need for Forex Market
Why should anyone buy and sell currency pairs?
Take you, for example; you are traveling from the US(assuming you’re a US citizen) to France.
You feel the need to buy a painting for your wife, from France, which you cant buy with US dollars. So you exchange the US dollars for Euro. As a result, you enjoy a hassle-free shopping.
Whereas, Euro has no use back home. So when you return home, you exchange the Euro, you have left, for Dollars. But, in the meantime, the rates have changed. Therefore you end up in a gain.
This is what Forex trading is all about. These fluctuations in the price are what speculators and traders are looking to capitalize.
If you’re thinking, only a small percentage of people travel abroad, and the resulting change in rates is going to be minuscule, you’re wrong. It is a 5 Trillion Dollar market.
The Forex market is dominated and controlled by banks, who transact currency on behalf of importers and exporters.
The relationship between Import, Export & Forex Market
Take Microsoft for example; they’re selling their goods across the globe. When they sell their products to Japan, the Japanese buyer has to buy US dollars in order to pay the Microsoft. Therefore, the demand for US Dollar rises.
And when Microsoft buys spares or hardware from the Japanese, they buy Japanese Yen to payback. In this case, the demand for Japanese Yen rises.
In a nutshell, if you buy a currency, you’re betting that its exports are going to rise and its economy is going to be strong. And the vice-versa, if you sell. But the tricky part is, exporters don’t like the home currency to rise since it decreases the profitability and at times, they go out of business too.
The cycle plays out on and on. Hope this helps you to understand the trade war in a better way.
You can’t merely buy a currency. You can only buy or sell a currency against another currency. Hence, they are available as pairs.
If you’re buying the currency pair EUR/USD- it literally means you are buying Euro and selling USD. Buying means ‘Going Long’ in the field of trading.
Likewise, if you sell EUR/USD, it essentially means you are buying US Dollar and selling Euro. And, selling means ‘Going Short’.
Types of Currency pairs
There are three types of currency pairs in the Forex market, on the basis of their trade volume. They are Major Currency Pairs, Minor currency pairs and Exotic currency pairs.
Major Currency pairs
There are 7 major pairs and they are the most sought out pairs by Forex traders.
Notice anything common all the major currency pairs?
Yes, it is the US Dollar. It is the Major among the Majors.
Importance of the US Dollar in the Forex market
The US economy dominates the entire global market in every way. Be the boom or the doom in the Global markets – US Dollar is either the reason or the cause.
The reason being large corporations are either incorporated at the US or have their significant chunk of their customer at the US.
Adding to that, most commodities like Gold, crude oil, etc. are traded in dollars. Most countries have the US Dollar as their reserve as well.
So the world economy, as a whole, relies on the dollar to be strong against its peers.
Popular Major Currency Pairs
EURUSD is the most traded pair among the major currency pair as well as in the Forex market.
It involves the two largest and powerful economies namely the USA and the Eurozone.
Hence, it is the most sought out pair.
The British pound was the world’s currency reserve prior to the US Dollar. So, its a match of former champion vs. current champion of the forex market.
Hence, traders can expect serious fireworks when the champions fight it out.
Two of the largest automobile exporting countries go head to head.
Volatility and spread tend to be on the higher side.
Wondering, why Swiss franc is featuring on it. It is because the investing community considers Swiss Franc as a safe-heaven.
When the elsewhere market goes down, Swiss Franc becomes the most sought out major currency pair.
Commodity Currency Pairs
Sometimes, the commodities play a more significant role in the following major currency pairs; and other times major pairs play a significant role in the commodities price. So either way, commodities have a significant influence on the Forex Market.
Mining is the leading industry in Australia. The raw material for many industries, like base metals, is the output from the Aussie mines.
Hence, AUDUSD is often examined by large corporations and investing community.
Similar to the Aussies, Kiwis are also miners.
The commodities are the major import for US industries, and hence NZD currency pair value can significantly effect on the economy itself.
The North American Derby. The US depends on raw materials like Natural gas and Timber from Canada.
The natural gas import can significantly impact US Economy due to its essentialness in the long winter.
Minor Currency Pairs
Gone are the days, when businesspeople and traders converted every currency pair to US Dollar to get the cross currency rates.
Take out the US Dollar from the major currency pairs and cross them against each other. You get Minor currency pairs aka Cross Currency Pairs.
The cross currencies have a higher spread and volatility compared to the major currency pairs.
Popular Cross Currency Pairs
Great Britain is a supreme economic power comprising about 3.5% of world GDP.
And, Britain’s most significant trading partner is the Euro Zone. Hence, this pair is highly sensitive to trade-related news of either region and is under the radar of investors all the time.
Investors consider Greenback as the safest investment across the asset classes. The Swiss franc takes precedence when the Greenback fails.
EURCHF is one of the prominent pairs, in which investors take cover during turbulent times.
In the field of Forex trading, when any of rest of the currencies, combined with US Dollar, the resulting pair is Exotic currency pair.
As the name suggests, they are unusual in the Forex market. But when traded, can yield higher returns.
The risk associated is also higher. Hence, even the renowned traders and experienced speculators stay away from the exotic currency pairs usually.
For a retail trader, it is better to stick around major and minor currency pairs, and completely avoid Exotic pairs.
Feeling overwhelmed? Here is a quick recap of the learned things. Talk about the Forex market and amaze your friends, like a pro, with these Forex terms.
Forex means Foreign Exchange market- the place where currencies are bought and sold.
Buying is called Going Long whereas Selling is called Going Short in Forex trading.
Major currency pairs are the combination of USD with any one of these pairs EUR, GBP, JPY, CHF, AUD, NZD, CAD.
When the same pairs were crossed against each other excluding USD, they are the cross-currency pairs or Minor currency pairs.
Exotic currency pairs are the ones when any other currency combine with USD.
When you are new to the Forex market, it is better to avoid minor and exotic currency pairs due to high spreads and volatility.