Despite the fact that the Forex market is the biggest investor market in the world — in which $5.3 trillion is traded every day — too many people don’t understand the huge opportunity it provides. It’s best to begin with a few basic facts about the Forex market before seeking the training and tools it takes to become a successful investor.
Here are 3 of the most important things every trader needs to know about the Forex market:
#1 – It all begins with a PIP. The smallest increment of trade in the Forex market is called a “pip,” which stands for “percentage in point.” Basically, the prices of currency pairs are quoted to the fourth decimal point in the Forex market. For another way to look at it, if you bought a cup of coffee at Starbucks for $4.30 (hey, it’s Starbucks!), in the Forex market that cup of coffee would be listed for 4.3000. Now, as prices go up or down, any change in that fourth decimal point (the ten-thousandths place) is called a pip, and is usually equivalent to 1/100th of 1% (note: the Japanese Yen does not follow this convention, and a quote including the Japanese Yen is taken out to just two places — that is, to 1/100th of the yen itself, instead of 1/1000th like other currencies).
#2 – Here’s what’s traded in the Forex market. The Forex market includes currencies from countries all over the world, but only twenty of the top currencies are used in about 93% of all trading. The more exotic currencies (such as the Czech koruna) have nowhere near the trading volume of the so-called “Majors,” which include these currency pairs: EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CHF, NZD/USD and USD/CAD.
The next most popular trading pairs are known as the commodity pairs, and they include AUD/USD, USD/CAD and NZD/USD. These seven pairs, along with other combinations such as GBP/JPY and EUR/CAD make up more than 95% of all Forex trading. Only 18 pairs and their crosses (pairs which do not include the USD) are actively traded by the majority of traders, which means the Forex market is much more compact for traders than the thousands of listings in the stock market.
Wondering about these abbreviations? Currency quotations like EUR/USD use the abbreviations for currencies that are prescribed by the International Organization for Standardization (ISO). Using this convention, the abbreviations for the major currencies include the US Dollar (USD), the Euro (EUR), Japanese Yen (JPY), British Pound (GBP), Australian Dollar (AUD), Canadian Dollar (CAD), and the Swiss Franc (CHF).
#3 – Here’s what’s actually being sold in the Forex market. In a way, you could say that nothing is really being bought or sold in the Forex market, because currencies never actually change hands. The trades that Forex traders place are merely ones and zeroes in a computer, with the market price determining profits and losses.
The Forex market was needed by big companies with locations around the world to allow consistent exchange of currency to easily pay for goods and services from foreign vendors, pay workers in the currencies they use and make corporate mergers and acquisitions easier to transact. These days, there is much more speculative trading in the Forex market, with 80% of all Forex trades coming from investors looking to profit. These speculative investors include hedge funds, large banks and, of course, individual investors who appreciate the tremendous opportunity offered by Forex trading.
Despite the fact that in the Forex market one Euro is not packaged up and sent to the U.S. in exchange for one US physical dollar, the consequences for investors are the same. Whenever a trader sells one standard lot of EUR/USD (where a standard lot equals 100,000 units), that trader has basically given up euros for US dollars — making the investor short on euros and long on dollars.
Going back to our Starbucks example above, when you pay your $4.30 for your coffee, you are short the $4.30, and long one coffee. Starbucks is long $4.30, and short one coffee (probably a Grande…). This is exactly the same as what investors are doing in the Forex market with pairs of currencies.
There is a great deal to learn about trading the Forex market, and experts in the field are always ready to help you get started trading right. Take time to understand the Forex market before you dive in, and you’ll be in a much better position to profit as you gain experience.