Forex: What's The Big Deal?

Forex (Foreign Exchange), not so foreign after all! If you are planning to take a vacation outside the US anytime soon, the truth is you will be trading currencies and you won't even know it.

After all the Foreign exchange relates to the respective value between currencies and so if you were planning to travel to Europe you would have to purchase Euros.

As luck would have it, you'd have to dig deep into your pocket and let go of quite a few of your hard earned Dollars to purchase the almighty Euro but that's another subject!

If we take the afore mentioned currencies, the cost of purchasing one Euro on April 9th 2008 is 1.58290 USD which is exactly what the Foreign exchange is, namely the exact quantity of one currency unit to buy or sell one unit of another currency.

This process is also called pairing. In this case EUR/USD at 1.58290 means that one Euro costs 1.5820 USD. Pairing can be reversed and USD/EUR at 0.631671 means that for less than a Euro (0.631671) our European partners can purchase one US Dollar!

Now, if you owned Japanese Yens for example and wanted to purchase Euros with them, EUR/JPY at 161.178 you'd need 161.178 JPY to buy one Euro. Since there are no USD involved in this specific transaction we no longer call it a pairing but a cross rate!

What about them Foreign Exchange Systems then?

Well, they come in two flavors, FLEXIBLE or FIXED. In the Flexible Forex Rate System, the central bank is responsible for adjusting the exchange rate according to supply and demand.

The Fixed Forest Rate is my more rigid in that currencies are fixed to each other at a determined rate. The central bank then acts as buffer in order to maintain the market value of the currency.

So if the price of foreign currency increases, the Central Bank must sell that currency in order to avoid any price increase. Conversely, in the even that there is a decrease in the market currency value so will the Central Bank need to purchase additional currency in order to maintain a stable market price.

To understand this better, the foreign exchange is like a pendulum with prices swinging from one side to another. The goal of the Central Bank is to ensure that the pendulum doesn't move and if it does to buy or sell in order that all the movements come to an end.

It's all about pennies!

Or lots of them.. In fact way more than lots of them since the Forex market in the biggest market in the financial world and that's just not here but throughout the world. If you ever wondered why exchange and forex traders seemed to be rolling in it, it's because they really are!

It is a market so large that you would need 12 zeros after the digit 2 to get an idea of how large it is and that's just the figure for a single daily turnover.

So if I align the numbers, 2,000.000.000.000 USD are traded worldwide every single day! Or two thousand million USD or if you're a Forex Killer Trader, two trillion Dollars!

The Forex market is an over the counter market with no physical location, central exchange and or clearing houses. Indeed, all it is, is an electronic network of banks, corporations and individuals purchasing, "trading", currencies from one another. Open 24 hours a day, it is uniquely suited to both end of the business spectrum, namely corporate institutions and independent or at home traders.

These Forex Traders, or FX traders negotiate prices each is prepared to buy and sell and these values are then fed into computers to be displayed on official quote screens.