Trading is buying and selling of securities, goods, commodities or services.
Definition of Forex Trading
Forex (foreign exchange) trading means trading of currencies of different countries of the world against one another. Usually, forex trading can be implemented with the help of a broker or market maker.
In the forex market, when the relative value of one currency unit is quoted against the unit of another currency, the currencies of the two countries are denoted by a pair and this is denoted as a currency pair. Here, the currency being used as a reference is called as quote or counter currency and that which is quoted in respect to the former is called as base or transaction currency. As gold and silver are commodities in the true sense of the word, they are also traded in U.S. dollars as commodity currencies.
Consider a forex trade between theUnited StatesandIndia. The currency ofU.S.is the U.S. Dollar and that ofIndiais the Indian Rupee.
The forex trade is said to be done when the Indian Rupee is bought and simultaneously the U.D. Dollar is sold by placing a buy order on this currency pair. This is called “going long” on the INR/USD. The quote for this currency pair is denoted as USD/INR=55, where the USD is the base currency and INR is the quote currency.
So the quote USD/INR 55 means that 1 U.S. dollar is exchanged for 55 Indian Rupees. It also means that considering the volatility of the market, the trader feels that 1 U.S. dollar will become more valuable as compared with 55 Indian Rupees and a long trade when placed on this currency pair suggests that one is going long on the US Dollar and going short on the Indian Rupee at the same time.
The categories of currency pairs are as listed below:
Majors: As the term implies, Majors are the forex currency pairs of major countries and the U.S. dollar. A typical Major Forex Currency Pair would be EUR/USD i.e. The Euro vs. the U.S. Dollar also designated as Fiber.
The Majors being the most traded pairs of world currencies, they represent the leading share of the forex market. As such, their market liquidity is very high. Also, it is to be noted that during the trading of major currency pairs, one has to closely follow the performance of the U.S.dollar and place utmost importance on the same. The same is not the case with its pairing currency unless the strengths of both the currencies (i.e., the U.S.D and its pairing currency) are quite comparable and both are almost equally strong. This happens when both countries exhibit continuous economic progress. Now as the USD is rather erratic, this trading can be unpredictable. Still, it is considered that major currency trading is quite a rewarding affair. Examples of major currencies are the U.S. Dollar, Euro, Canadian Dollar and Swiss Franc.
Cross Pairs: Those currency pairs which do not feature the U.S. dollar are called cross pairs.
Example: EUR/ JPY i.e., Europe andJapan
When one of the participating currencies is a Euro, the currency pair is called as euro cross.
The following pairs are most traded because of their liquidity:
EUR/CHF, EUR/JPY, EUR/GBP
CHF denotes the Swiss Franc. CH here traces its roots toSwitzerland’s Latin name of Confoederatio. Due to its comparatively low interest rates, CHF is a much preferred currency for forex trading.
In cross currency trading, it is an advantage when there is difference in the rates of interest, geopolitical effects and other such characteristics between the two trading countries.
Exotics: Here, currencies of developing countries are called exotics. The term ‘development’ here refers to industrial economy with respect to the major countries.
‘Exotics’ currencies are Baht of Thailand, Peso of Uruguay, Dinar of Iraq, etc. They are considered to trade narrowly and are pricey due to the lack of market depth in the transactions.
Importance of Forex Trading
Forex trading has gained importance due to the distribution of trading between countries far and near, encompassing the whole world. A trader can trade more money on the market than the amount in his account. This is called ‘leverage’ and is an attractive proposition for him. Due to the sizeable trading volume, there is a considerably high liquidity and also the low transaction cost with almost non-stop periods of operations (excluding weekends) from the Sunday evening of Australia as soon as the markets open, to the Friday of New York after they close down makes forex trading very lucrative. In addition, there is no ceiling on directional trading and so the trader can either buy or sell (go long or short) the currency pair anytime.