Pipruit: Well, we’ve just investigated that the FOREX is a money market, so I assume that the trading object of the market is MONEY.
Commander in Pips: That’s right son.
Pipruit: But I do not quite understand one thing. The point is that if we want to buy something, we should pay money for it. And here, on FOREX, we should pay money for purchasing the same money. I’m confused a bit.
Commander in Pips: Well, I’ll try to help you. You just have said: “we should pay money for purchasing the same money”. But this is not quite correct. You pay money, yes, but purchasing not the same but different money.
Commander in Pips: You never buy on the FOREX market US dollars for US dollars, because this transaction makes no sense. It’s the same like you come to your fellow once and tell him – say, let’s change – I’ll give you 5 bucks for your 5 bucks. He may think that you’ve gone nuts. But if your friend has some different money, like Japanese Yen left over from his recent trip to Japan, this will be quite different story…
Pipruit: Oh! I think I’ve got it. It makes sense to trade currency of different countries with each other, but not a currency with itself, because the exchange rate of a currency with itself never changes.
Commander in Pips: Right you are.
Pipruit: But what is the economic basis for this, why are rates changing all the time?
Commander in Pips: Well, as you know, currency is the blood of the national economy of a country. It means that the rate of currency relative to other currencies depends on the fiscal health and perspectives of each country. This fact explains why currencies rates fluctuate all the time.
Commander in Pips: If, for example, you see that EU economy does not show growth and looks like it is bad and getting worse, but Japan’s economy is behaving well and is improving- it seems logical to buy Yen for Euros. In fact, all positive and negative national issues, not only economic but also a political, find their way into the currency value. Furthermore, not only those that have happened already, but those that were announced or are expected to happen in the future by market participants.
Pipruit: Sounds like buying equities. But instead of different companies these are different national economies, and instead of stocks these are currencies. It seems that when I’m buying one or another currency, I’m buying a share in the national economy that this currency belongs to.
Commander in Pips: “Buying a share in the national economy that this currency belongs to.” Nice conclusion, son, even I couldn’t say it better. Absolutely right!
Pipruit: I think I’m starting to understand the concept. The last question…When we choose equity to purchase, we have confidence or assume, at least, that this equity and their company will perform better than their rivals. It’s absolutely clear. But what is about currencies?
Commander in Pips: Absolutely the same. For example, when you’re buying Yen for US dollars, you expect that the Japanese economy will outperform US economy during the time while you intend to hold Yen position. If you are right, then you will exchange Yen for bucks after some time and make some profit, because yen rate will become higher and you will get more US dollars for the same amount of Yen during reverse exchange – when you sell the Yen for dollars. Generally speaking, the exchange rate of one currency to another reflects the relative power, condition and perspectives of that country’s economy, compared to other one.
Pipruit: Ok, I’ve got it! It’s not so complicated like it seemed in the beginning. And what particular currencies are traded on FOREX?
Commander in Pips: Most of the currencies in the world are traded. That’s too big to get into nopw. Let’s say I specify the major ones first. They are EUR, USD, NZD, JPY, CHF, GBP, CAD, and AUD…
Pipruit: Hold on, hold on… Let’s say I’ve guessed that USD is “US Dollar”, but what are some others?
Commander in Pips: Ok, the question is accepted. Let’s me explain the name system. All pairs have three-letter names. First two letters mark the country, and the third letter marks currency. So, for example – GBP, “GB” stands for Great Britain, “P” – stands for Pounds.
Pipruit: Cool, now let me guess, that “CA” means Canada, and D means Dollar.
Pipruit: Thanks, but let me one more question, Chief. Once I’ve heard how a FOREX trader was screaming on the phone “Buying cable, buying cable!” But cable looks like a commodity rather than a currency and we’ve just come to conclusion that FOREX is a money market.
Commander in Pips: This is simpler than you think. The point is that some currencies also have nicknames and Cable is a nickname of the GBP. Ok, I’ll also add some of the common nicknames into the table.