You know the advantages of trading
forex, and you are excited to start trading. Now you need to learn what this
market is all about. How does it work? What makes currency pairs move up and
down? Most importantly, how can you make money trading forex?
Every successful forex investor
begins with a solid foundation of knowledge upon which to build. Let’s start
with currency pairs—the building blocks of the forex market—and how you will be
using them in your trading.
In this first section, we will
explain the following to get you ready to place your first trade:
- What a currency pair is
- How you can trade a currency
pair
- What happens when you trade a
currency pair
- Everything is relative in the
forex market.
The euro, by itself, is neither strong nor weak. The same holds
true for the U.S. dollar. By itself, it is neither strong nor weak. Only when
you compare two currencies together can you determine how strong or weak each
currency is in relation to the other currency.
For example, the euro could be
getting stronger compared to the U.S. dollar. However, the euro could also be
getting weaker compared to the British pound at the same time. Currencies
always trade in pairs. You never simply buy the euro or sell the U.S. dollar.
You trade them as a pair. If you believe the euro is gaining strength compared
to the U.S. dollar, you buy euros and sell U.S. dollars at the same time. If
you believe the U.S. dollar is gaining strength compared to the euro, you buy
U.S. dollars and sell euros at the same time. You always buy the stronger
currency and sell the weaker currency.
Currency pairs are typically
divided into the following three major groups:
- Major currency pairs
- Exotic currency pairs
- Currency
crosses
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Major Currency Pairs
Most forex investors begin by investing in the major currency
pairs, or the majors. The majors are those currency pairs that are comprised of
the most important currency in the global markets—the U.S. dollar (USD)—crossed
with one of seven other globally significant currencies—the euro (EUR), the
Great British pound (GBP), the Swiss franc (CHF), the Japanese yen (JPY), the Canadian
dollar (CAD), the Australian dollar (AUD) and the New Zealand dollar (NZD).
Take some time
to learn the following major currency pairs because you will most likely be
using them extensively:
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EUR/USD
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(Euro /
U.S. dollar)
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GBP/USD
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(British pound / U.S. dollar)
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USD/CHF
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(U.S. dollar / Swiss franc)
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USD/JPY
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(U.S. dollar / Japanese yen)
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USD/CAD
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(U.S. dollar / Canadian dollar)
|
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AUD/USD
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(Australian dollar / U.S. dollar)
|
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NZD/USD
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(New Zealand dollar / U.S. dollar)
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Exotic Currency Pairs
The exotic currency pairs, or the exotics, are the currency pairs
that are comprised of the most important currency in the global markets—the
U.S. dollar (USD)—crossed with any currency that is not considered a major currency.
Exotic currencies—like the Swedish krone (SEK), the South African rand (ZAR),
or the Mexican peso (MXN)—are called exotic because they are associated with
illiquid currencies that might not be available in a standard trading account.
Exotic currencies are usually lightly traded and have large
bid/ask spreads. However, many so-called “exotic” currencies are becoming more
popular and more and more investors are trading them.
Take a look at the following list of exotic currency pairs because
you may be interested in diversifying your forex portfolio with a few
uncorrelated currency pairs:
|
USD/SEK
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(U.S. dollar / Swedish krone)
|
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USD/NOK
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(U.S. dollar /
Norwegian krone)
|
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USD/DKK
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(U.S. dollar / Danish krone)
|
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USD/HKD
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(U.S. dollar / Hong
Kong dollar)
|
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USD/ZAR
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(U.S. dollar / South African rand)
|
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USD/THB
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(U.S. dollar / Thai
baht)
|
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USD/SGD
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(U.S. dollar / Singapore dollar)
|
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USD/MXN
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(U.S. dollar /
Mexican peso)
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Currency Crosses
Currency crosses, or the crosses, are the currency pairs that are
comprised of any two currencies—so long as neither of them is not the U.S.
dollar (USD). The euro (EUR) paired with the British pound (GBP) or the
Australian dollar (AUD) paired with the Japanese yen (JPY) would be considered
currency crosses.
The following is a list of some of the more popular currency
crosses:
|
GBP/JPY
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(British pound / Japanese yen)
|
|
EUR/GBP
|
(Euro / British pound)
|
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AUD/JPY
|
(Australian dollar / Japanese yen)
|
|
EUR/CAD
|
(Euro / Canadian dollar)
|
|
CAD/JPY
|
(Canadian dollar / Japanese yen)
|
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TRADING CURRENCY PAIRS
Investors, just like you, make money every day by trading currency
pairs. By determining what is going to happen to a currency pair in the future,
investors can act today to take advantage of coming price movements.
Currency pairs can do one of the following three things:
|
- They can go up
- They can go down
- They can go sideways
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Before you can determine if a currency pair is going to be going
up, down or sideways, however, you need to determine which currency in the pair
is getting stronger and which currency is getting weaker, compared to the other
currency. For instance, if you are looking at the EUR/USD (euro / U.S. dollar)
pair, you have to decide if the euro is getting stronger than the U.S. dollar
or if the U.S. dollar is getting stronger than the euro.
Note: The first currency listed in the currency pair is called the
base currency and the second currency listed in the currency pair is
called the quote currency. When you look at the price of a currency
pair, it tells you
How many of the quote currency it would take to buy one
unit of the base currency.
If the base
currency is strengthening against the quote currency, the currency pair will be
moving up. If the quote currency is strengthening against the base currency,
the currency pair will be moving down. If the base currency and the quote
currency are equally strong, the currency pair will be moving sideways.
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The
following is a quick reference to help you remember which way a currency pair
will be moving:
-
Base > Quote = Up
-
Base < Quote = Down
-
Base = Quote = Sideways
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Once you have decided which way
the currency pair is going to move, you can place your trade. When trading
forex, you can do one of the following three things:
§ You can buy the currency pair
§ You can sell the currency pair
§ You can do nothing
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