Welcome to global financial markets! Just as a trader or investor buys stocks in a company, the foreign exchange (or FOREX for short) allows you to buy and sell currencies, like owning a piece of the future rise or decline of an entire country's economy.
In the following Forex Trading Course, you will learn how to make money by trading currencies. The course has four parts and gradually explains the fundamentals (what is FOREX, what influences the markets, currency pairs, how to read a forex chart, trends and trendlines, how to use forex indicators, and how to choose the best forex broker for you).
Plenty of things to learn, so we better start!
1. What is Forex?
Forex is short for 'foreign exchange' – the game of buying and selling various currencies in the foreign exchange market.
In the global foreign exchange market, retailers, investors, speculators, and institutions determine the relative value for converting one currency to another via buying and selling currency pairs.
It's a dynamic, liquid marketplace with a daily turnover of more than 5.3 trillion dollars.
The trade-in Forex occurs between two currencies because one currency is being bought and another is sold simultaneously.
Now that you know what the Forex market is let's find out what influences the currency movements and influence the forex market.
2. What Influences the Forex Market
Let's examine the five main factors that influence the value of a given currency in rapport to another.
2.1 Supply and Demand
To determine where a country's economy may be headed next, traders turn to various data, including gross domestic product (GDP), imports, exports, employment, unemployment, growth, debt, etc.
Collectively, these are often referred to as the fundamentals.
Like any other market, the value of currencies responds to changes in supply and demand. For example, when the world needs more dollars, the dollar is worth more. When too many dollars are available on the market, or the need for them declines for some reason, the dollar drops in value.
2.2 Currency Pairs
The world's currencies trade in pairs - one currency's value either rises or drops compared to another. Each currency has a 3-letter abbreviation, and the trailing currency of any pair is considered the base currency. The price at any given time tells you how much of the base currency is needed to equal precisely one unit of the leading currency.
For example, when the EUR/USD pair is priced at 1.5000, this means that it takes 1.5 US Dollars to exchange for 1 Euro. If the Euro rises in value, then the EUR/USD price will also increase, as more U.S. Dollars are needed to buy each Euro. Likewise, if the Euro drops in value, then the price of the EUR/USD pair will also drop, as now you need fewer U.S. Dollars to be equal to each Euro.
The value of the leading currency is not the only factor in the value of a particular pair. Any change in the base currency value also affects this relationship.
So, in the same example, if the U.S. Dollar now rises in value, then the EUR/USD pair would drop, as now you need fewer dollars to buy each Euro. And if the U.S. Dollar drops in value, then the EUR/USD price would rise, as you need more of those U.S. Dollars to equal each Euro. Therefore, You can say that each currency pair goes up and down in value proportionately to the rise or drop in the value of its leading currency.
Likewise, the same currency pair also moves up and down in an inverse relationship to the increases or drops in the value of its base currency; hence, if a trader expects that the U.S. economy will go up and the value of the U.S. Dollar with it, then they may wish to sell the EUR/USD pair since it will most likely go down in price in such a scenario.
If the trader believes that the European economy will go up, bringing up the value of the Euro, then they would buy the EUR/USD pair instead.
2.3 Interest Rates
Another critical factor that influences the value of a given currency is the interest rate that the central bank of a specific country charges for the use of its money. These interest rates are constantly changing, so it is wise to keep track of them.
For example, if the Federal Reserve in the United States (commonly referred to as the FED) lowers its interest rate, then typically, the value of the U.S. Dollar will drop as well, causing the EUR/USD pair to rise.
If the Fed raises rates, the U.S. Dollar will typically go up, causing the EUR/USD to drop. The Fed's counterpart in the European Union is the European Central Bank (the ECB). If they raise their interest rate, then usually, the value of the Euro will go up as well, causing the EUR/USD to rise. If they lower their interest rate, the Euro will typically drop in value, causing the EUR/USD to fall.
Central banks are constantly caught in a delicate balancing act. If a country's currency rises too far, its exports become too expensive, and other countries may look elsewhere. Interest rates are sometimes also cut to stimulate the economy, but if they get too low, then inflation can set in. Then it is time to start raising them again to slow growth.
Higher interest rates also tend to attract more foreign investments (which is why that country's currency frequently goes up in step with the interest rates); meanwhile, cheaper interest rates tend to stimulate lending inside the country and, therefore, economic growth.
2.4 Political News
The political landscape plays a vital role in the overall outlook for a country and, consequently, the perceived value of its currency. Forex traders are constantly monitoring political news and events to anticipate changes in the economic policies of national governments. These can include shifts in government spending and adjustments in regulations imposed on particular sectors or industries.
Exchange rates often react favorably to wins by pro-growth or fiscally responsible parties. A referendum can also have a substantial impact on exchange rates. A good example is the Brexit vote, which dramatically affected the British pound when the U.K. voted to leave the E.U.
Any government's fiscal and monetary policies are the most critical factors in its economic decision-making. Central bank decisions that the forex market keenly watches impact interest rates for any changes in critical rates or the future outlook of policymakers.
2.5 World events
Geo-political events, crises, and impending elections can all affect the strength of a currency based on how that affects the perception of a country's stability. A positive event can attract foreign investors, with a rise in foreign capital increasing the currency's value. A country in crisis can lead to a loss of confidence and depreciation of its currency value.
For instance, look in the picture above at the RUB/USD currency rate fluctuations when the Russian Federation invaded Ukraine on Feb 24, 2022.
3. How to Read a Currency Quote?
Forex is the business of currency conversion, and since you are constantly comparing the value of one currency to another, FOREX is always quoted in pairs.
For example, the quote of EUR/USD shows how many U.S. dollars you will get for one Euro.
The first currency is called the base; the second is called the quote. When you buy a currency pair, you buy the base currency and sell the quote currency. Simple.
MAJORS are widely traded by beginners and professionals alike. They have the most liquidity, lowest spreads, and the broadest range of movements. Unlike minor currencies, majors are generally more stable. These nations' economic and political institutions are usually long-established and predictable compared to other countries.
MAJORS pairs: EUR/USD, USD/CHF, GPB/USD, USD/JPY, EUR/JPY, USD/CAD
THE CROSSES are any currency pair that doesn't feature the USD, and they do not hold any less profit potential than the majors. Too much U.S. Dollar exposure can lead to all your trades heading in the same direction, a big problem if that direction is against you.
Popular Crosses pairs: GBP/JPY, EUR/GBP, CAD/JPY, AUD/CAD, EUR/AUD, NZD/JPY.
THE "EXOTIC" currency pairs are less traded and more costly to buy or sell. Don't let the cost put you off because many of the greatest traders made their fortunes with exotics. For example, one of the five greatest forex traders, George Soros, gained $800 million in profit from selling Thai Baht (THB) in the 1997 Asian crisis.
Popular Exotic pairs: USD/TRY, EUR/TRY, USD/ZAR, USD/MXN, USD/SGD, EUR/SEK
4. What is a Pip?
The most famous piece of the terminology used by forex traders has got to be the humble 'pip.'
A pip is simply a unit you count profit or loss in.
Typically, forex pairs are quoted to four decimal places (0.0001). The '1', four spaces after the 0, is referred to as a pip.
The number '7' in red shows the decimal unit of a pip.
If a trader buys GBP/USD for 1.6000 and then, later on, sells it for 1.6020, that's a difference of 0.0020 or 20 pips.
The exception is Yen pairs ( i.e., USD/JPY), which are only quoted to two decimal places. In this case, the second spot after the 0 is referred to as a pip.
In the first part of our four parts course on forex trading for beginners, you learned what the Forex market is the factors that influence the Forex markets (Supply and Demand, Currency Pairs, Interest Rates, Political News, and World events). How to read a currency quote and what a PIP is.
Now that you're up to speed let's move on to the second part of the guide, where you will learn to read a forex chart.
You can skip the second part and move into more advanced stuff but I highly don't recommend it if you are a forex beginner:
- Forex Trading Course for Beginners - Forex Indicators & Strategies [Part 3/4]
- Forex Trading Course for Beginners - Fore Trading Systems & Brokers [Part 4/4]