TOWER ONE FX GROUP

So what is Forex really all about?

Forex is an abbreviation for Foreign Exchange and when we talk about foreign exchange we refer to the exchange between foreign currencies. Almost every country on this planet has their own currency. In Japan they use a currency named the Yen (symbol: ¥) and in Spain they use a currency called the Peso (as a name available in other Spanish speaking countries like Mexico, although it is not the same currency). The currencies that are traded very often (usually countries with large economies and significant exports and/or imports) have their own symbols, like the Yen that I mentioned before:

US Dollar, symbol: $ or US$
Euro, symbol: €
British Pound, symbol: £
Japanese Yen, symbol: ¥

You probably recognize these symbols when you have been exchanging your cash into the currency where you are traveling. What is Forex then as compared to the exchange you make when you travel. The foundation is exactly the same, we exchange one currency for another, the difference lies in the objective of the exchange. When you exchange for travel, our objective is to be able to spend on things that you need when arriving in that country. Our objective in Forex trading is simply to make a profit by taking advantage of currency exchange rate changes over time.


When you want to make a currency exchange the bank (or wherever you make you exchange) will quote you an exchange rate. Let's say you want to go to Europe, visiting France, Spain and Italy before returning home. In these countries the Euro is prevailing. Assuming you are living in th USA, the conversion will be made between US$ and Euro. Since we are exchanging two currencies the quote can be made either as US$ in relation to Euro or Euro in relation to US$. However we look at it we are dealing with a currency pair. This is one of the basic features of Forex – every quote is a the exchange rate between two currencies or a pair. Thus the quote is made as follows:

US Dollar / Euro, for example 0.708
Euro / US Dollar, for example 1.413

If you invert the one you get the other of the two pairs above and it is reflected in the quote. The way to read any of the two quotes is to set the first currency to 1 (one). Then you get as follows for the US Dollar / Euro exchange rate:

“1 (one) US Dollar will buy me (exchange to) 0.708 Euros. Or if you want to exchange 100 US Dollars you will end up with 70.80 Euros (in this example).”

The first currency is always equal to 1 (one) and the second currency is what you get at the exchange rate specified. So the Euro / US Dollar exchange rate becomes:“

1 (one) Euro will buy me (exchange to) 1.413 US Dollar. Or if you want to exchange 100 Euros you will end up with 141.30 US Dollars (in this example).”


When you ask a question like “ What is Forex ? ”, you open up a whole world of esoteric knowledge. Don't be alarmed, it is all getting to be familiar very shortly. Take the above quotes, it might seem a little strange now, but everything about Forex is actually very simple, nothing complicated at all. To get an exchange rate between a currency pair we don't take $5 and divide it with €10, no we are not dealing with absolutes but with relatives. In other words the relationship between US Dollar as a whole and the Euro as a whole. Actually it would be more appropriate to say we are focusing on the relation between the US economy and the EU (European Union) economy, which is reflected in the exchange rate of the US Dollar and Euro.


If we were to compare Forex trading with Stock trading, the equivalent would be something called pairs trading. Most people have an idea of what the stock market is and how it works. Now, in pairs trading would take two companies and divide the one company's share price with the other, hence getting a ratio or rate. For example, divide the share price of US Steel with Alcoa and you will have a share rate between two companies. In our case we instead have a currency rate, a comparison between two currencies.

As I said earlier, we compare the relative outlook of one economy with the relative outlook of another economy. Since we have two factors (economies) involved, we will have a double effect on the evaluation (rate) of the currency pair. For example, if the US economy is booming and the Euro economy is in a recession, then not only will the US Dollar be strong due to a healthy US economy, but the exchange rate against the Euro will also be boosted by the recession in Europe. In other words, not only is the US Dollar / Euro exchange rate strong because of the US economy it is also strong because of the weak Euro economy, which means that the Euro / US Dollar exchange rate will fall. Think about it, if the value of the dollar is increasing (it is because the US economy is booming) and the value of the Euro is decreasing (due to the recession) then is follows that the Euro / US Dollar exchange rate must fall.

We can look at this in another way by studying supply and demand. In general, when the demand for a product is high, the manufacturer of that product can keep the price high or even increase the price, just look at gold and oil since 2000. The same principles apply to currencies. If the demand of the US Dollar is high then the US Dollar will strengthen itself towards the currencies that can't show the same demand increase. This means that the value of the US Dollar is increasing.

In other words, the exchange rate of for example Euro / US Dollar will fall. So now the above exchange rate becomes for example:

“1 (one) US Dollar will buy me (exchange to) 0.880 Euros. Or if you want to exchange 100 US Dollars you will end up with 88.00 Euros (in this example).”

or

“1 (one) Euro will buy me (exchange to) 1.136 US Dollar. Or if you want to exchange 100 Euros you will end up with 113.60 US Dollars (in this example).”

As you might have understood by now the equilibrium is at the rate of 1.000. That means that the two currencies we are comparing are valued exactly the same. If the rate is below 1.000 then the first currency is weaker than the second. And if the rate is above 1.000 then the first currency is stronger than the second.

Let us now continue to answer you question, " What is Forex ? "
Currencies can be traded in many ways, the two most common ways are either as currency Futures or spot Forex. Currency Futures are traded on an exchange like CME (Chicago Mercantile Exchange) and are thus regulated and standardized with a standard contract size, single data feed and so forth. What we are talking about here is spot Forex and spot Forex is not traded on an exchange but between banks and other financial institutions directly (equivalent to OTC in stock trading). That's why spot Forex is also referred to as Interbank Forex. So spot Forex is not regulated by an exchange or agency, it as free as its gets in a pseudo-capitalist economy. This means that there is no single source for exchange rate data, but many.


You now understand the very basics of Forex.
A good step is now to study my Forex Trading Course. Enjoy!