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  4. FOREX - What is it ?

Part III. How are currencies traded in the FOREX market?

Commander in Pips: Well, the whole system of quoting prices is very simple. Currencies are traded in pairs. All possible pairs have already been created and available for trading. Other words, you will trade not a separate currency, but the pair and the quote is an exchange rate one currency to another.

Pipruit: Yesterday, I remember seeing something like this:​

Currency We Buy at We Sell at
1 EUR 1.35 USD 1.37 USD
1 GBP 1.65 USD 1.67 USD

Commander in Pips: For simplicity, let’s skip separate quoting for buy and sell (we will talk about it a bit later), and use just the first column - what does it mean?

Currency USD
1 EUR 1.35
1 GBP 1.65

Pipruit: Oh, it’s quite simple – I can exchange 1 GBP for 1.65 USD and 1 EUR for 1.35 USD
Commander in Pips: So that is the answer – GBP/USD and EUR/USD are currency pairs. When you make a transaction on FOREX you’re simultaneously buying one currency and selling another. For example, buying EUR/USD means Buy EUR and Sell USD. The first placed currency shows what are you buying or selling, and second one shows what you’re getting instead. Selling EUR/USD means that you‘re selling EUR and buying, i.e. “getting instead” USD.

Pipruit: When you’re explaining that, I have an association with pair of scales. On the one scale is the first currency, say EUR, on the other one is USD. And exchanging rate, i.e. equilibrium is fluctuating all the time, based on which currency is getting stronger right now.

USDJPY rate - Forex School​
Commander in Pips: Outstanding! That’s an excellent association. I see that you’re starting to have a real knack for all this stuff.

Now to your second question about “all possible pairs”. Here are three currencies – GBP, USD and EUR. How many pairs can you create with them?

Pipruit: Let’s see… we already know pairs like USD/USD or EUR/EUR do not make any sense, so I suppose that we can create only three pairs – EUR/USD, GBP/USD and EUR/GBP. Also we can make reverse pairs, such as USD/EUR, for example, but this will be the same pair as EUR/USD. The only difference will be that it will show how many Euros I should pay for 1 buck, instead of initially how much bucks I should pay for 1 EUR. If, for example EUR/USD rate is 1.35, then USD/EUR is 1/1.35 or about 0.74. It means that I should pay about 0.74 EUR for 1 buck.​

Commander in Pips: Very good! Indeed, FOREX does not have both EUR/USD and USD/EUR pairs simultaneously. This is because they are, in fact, identical. Ok, let’s add one more currency, say, CAD. What pairs can you create now?

Pipruit: It’s a simple task. I just have to add just pairs that include CAD. EUR/USD, GBP/USD and EUR/GBP we have already, so I need to add USD/CAD, EUR/CAD and GBP/CAD.
​
Commander in Pips: Right you are. So, do you understand now, what I mean with “all possible pairs”?
Pipruit: Yes sir, now it looks clear. But how many pairs exist in total? And are there any differences with trading them?​

Commander in Pips: There are a lot of pairs. Generally speaking, all pairs can be put into one of three groups – Majors, Crosses and Exotic.

Pipruit: Yes, we’ve talked about Majors previously. They are USD, EUR, GBP, CAD, JPY, AUD and NZD.​

Commander in Pips: Not quite. We’ve talked about “Major currencies” and now we’re discussing “Major pairs”. It’s not exactly the same.

  • Pipruit: What’s the difference, sir?​

    Commander in Pips:
    • All major pairs include the US Dollar with another “Major currency”. These have a leading share in total turnover on the FOREX market. Here they are:

      Pair Countries
      EUR/USD Euro zone / United States
      GBP/USD United Kingdom / United States
      USD/CHF United States/ Switzerland
      USD/JPY United States / Japan
      USD/CAD United States / Canada
      AUD/USD Australia / United States
      NZD/USD New Zealand / United States
    • Crosses are other combinations of “Major Currencies”. They include one major currency with another, but not with the US Dollar. You can construct them by yourself. I’ll just give you some examples. Euro crosses:

      Pair Countries
      EUR/GBP Euro zone / United States
      EUR/CHF Euro zone / Switzerland
      EUR/CAD Euro zone / Canada
      EUR/AUD Euro zone / Australia
      EUR/NZD Euro zone / New Zealand
    • or Japanese Yen crosses: ​
      Pair​
      		 Countries
      EUR/JPY Euro zone / Japan
      GBP/JPY United Kingdom / Japan
      CHF/JPY Switzerland / Japan
      USD/JPY United States / Japan
      CAD/JPY Canada / Japan
      AUD/JPY Australia / Japan
      NZD/JPY New Zealand / Japan

    Pipruit: Ok, Ok, I think I understand that.

    Pipruit: And what are exotic pairs?​

    Exotic pairs - Forex School​
    Commander in Pips: During recent times, the economies of emerging markets have becomes stronger, the trading turnover is rising, so on FOREX markets, there is more demand appeared for exchanging emerging market’s currencies as between themselves and with major currencies. For example, now we can trade on FOREX such currencies as Brazilian real, South Africa’s rand, Mexican peso, Thai baht, Russian Ruble, Singaporean dollar, Chinese Yuan, etc. Usually they are traded to US Dollar and sometimes with other major currencies. Occasionally, they are traded with each other. There is much will depend from your FOREX broker, because not all of them provide the possibility to trade exotic pairs or even their crosses. But, in general, these pairs exist and can be traded. Here are some examples of them:

    Pair Countries
    USD/HKD United States (dollar)/ Hong Kong (dollar)
    USD/SGD United States (dollar) / Singapore (dollar)
    USD/ZAR United States (dollar) / South Africa (rand)
    USD/THB United States (dollar) / Thailand (baht)
    USD/MXN United States (dollar) / Mexico (peso)
    USD/DKK United States (dollar) / Denmark (Krone)
    USD/SEK United States (dollar) / Sweden (Kronor)
    USD/NOK United States (dollar) / Norway (Krone)

    Due to lower size on economies of Emerging markets and their international Trade turnover, the trading volumes with exotic pairs is lower compared to majors and crosses. Besides, the transaction cost for trading them is usually higher.

Pipruit: I understand about pairs, but what are transaction costs? ​

Commander in Pips: Well, it’s a bit early to talk about that in detail, but I give you fast forward look. Let’s return to quote board in exchange centre:

Currency We Buy at We Sell at
1 EUR 1.35 USD 1.37 USD
1 GBP 1.65 USD 1.67 USD


See – there is a double quoting, one price is for buying the foreign currency and another for selling it. The difference between buy and sell price calls “bid/ask spread”. If you will buy Euro here for 1.37 (because bank sells Euro for 1.37 currently, this is “Ask” price) and at once sell it at 1.35 (because bank buys Euro only for 1.35, this is “Bid” price) you will get a $0.02 loss – that’s your transaction cost. In fact, you do nothing, because you stand with the same position - you Buy Euro and Sell Euro at the same time. Even so, you’ve just lost 2 cents. So, for major pairs the Bid/Ask spread on FOREX is very tight - usually 0.0001-0.0003, but for exotic pairs it’s much wider. It means that if you would like to make the same transaction with Thai baht, for example, you can get greater loss instead of 2 cents as it stands with Euro transaction. It can be 50 cents or even buck. You should remember that if you ever intend to trade exotic pairs. We’ve just talked about Bid/Ask spread but there are other sorts of transaction costs that exist also.

In general remember one simple rule – “the higher the transaction costs, the lower your potential profit from the trade”.

Comments

J
John Jensen
12 years ago,
Registered user
table shows:
EUR/GBP Euro zone / United States

should be:
EUR/GBP Euro zone / United Kingdom
J
John Jensen
12 years ago,
Registered user
and another one in the same (crosses) table:
EUR/AUD United States / Japan

should be:
EUR/AUD Euro Zone / Australia
J
John Jensen
12 years ago,
Registered user
same crosses table:

EUR/AUD United States / Japan
vs.
EUR/AUD Euro Zone / Australia


EUR/NZD Euro zone / New Zealan
vs.
EUR/NZD Euro zone / New Zealand
S
Sive Morten
12 years ago,
Registered user
Thanks Jonh,
we'll fix it...
B
Billy Pidu
7 years ago,
Registered user
Need to visit these pages again and reread. Concepts are still not settling well.
S
StrongKaze
7 years ago,
Registered user
Before you mentioned that cross pairs are those major currencies paired with other major currencies that aren't the US dollar, however on the table for the Japanese Yen crosses you have USD/JPY? Isn't this a major pair?
P
PipSqueak
7 years ago,
Registered user
> Before you mentioned that cross pairs are those major currencies paired with other major currencies that aren't the US dollar, however on the table for the Japanese Yen crosses you have USD/JPY? Isn't..
Sive can confirm, but I believe you are correct! USD/JPY is a major pair and so do not think it should be in JPY Cross table....but...could it also be a Major paired with a cross-dressing Japanese?
H
Hamza Samiullah
6 years ago,
Registered user
Nice... Little editing problems only...
F
fajrss
6 years ago,
Registered user
Well done.
When You put that way, it become easier to understand.
A
Anthony23
5 years ago,
Registered user
Yes, read everything. These methods of explanation are even better, I personally think so.
P
Pandoraju
5 years ago,
Registered user
So far so good. Thanks
A
arcskills
5 years ago,
Registered user
It all make sense
W
Watswats
3 years ago,
Registered user
Enjoying every step of the course. Looks forward to its end..
M
Manu_el
3 years ago,
Registered user
Hi, I struggle to understand one thing: if I want to buy eur / usd does it mean that I buy euro and sell usd, this does not mean that first I have to buy usd to then be able to sell it and buy eur?
P
Pharaoh
3 years ago,
Registered user
Manu_el,

Your broker will charge spread, rollover, and possibly commission in the currency of your account. Any cost of conversion should be covered by those fees. Profits and losses should be shown in your account's currency.
R
RuthK
2 months ago,
Registered user
Getting a bit complex now..hope I can keep up... :(

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