Basics of Forex (Foreign Exchange) Trading

The key element of the forex exchange is the currencies that are bought and sold in this market. Foreign exchange transactions involve an exchange of currencies between countries. Fluctuations in the value of a currency against another offers opportunities for forex traders to make a profit.

All currencies are traded on the foreign exchange market, but some of them are considered major currencies, as they dominate the global transactions. The value of other currencies is generally regarded as the counterpart of the major currencies.

The main currencies in forex

The most popular currency is the U.S. dollar (USD). 80% of forex transactions are done using this currency. With the collapse of the gold standard and the adoption of the Bretton Woods system in 1944, the U.S. dollar became the global reserve currency. All currencies are measured against the U.S. dollar.

The euro (EUR) is the currency of the euro area which consists of 27 Member States. With more than €610 billion in circulation since December 2006, the euro surpassed the dollar in terms of total cash in circulation. The value of the euro has been affected by factors such as unstable growth rates and unemployment.

Another major currency is that of Great Britain, the pound sterling (GBP). The pound sterling was hit hard by the growing popularity of the U.S. dollar. The Great Britain pound is actively traded against the euro and U.S. dollar. This currency is also called "cable" by the trader, because this was the first currency to be traded on the foreign exchange market through transatlantic cables.

The Japanese yen (JPY) is the third most traded currency on the forex market, just behind the U.S. dollar and the euro. The trading strategy of carry trade has led to the strengthening of the yen with the 2008 financial crisis that has forced all countries to reduce their interest rates.

The Swiss franc (CHF) is considered a safe haven because of its neutral and independent economy and its private banking system. This currency lacks liquidity on the market, though, which makes it very volatile.

Currency trading on the forex exchange

Forex currencies are always traded in pairs. The following currency pairs represent about 70% of total daily trading on the forex market. Forex traders tend to stay away from exotic pairs (such as those including the Polish zloty).

Euro / US Dollar - EUR / USD
British Pound / US Dollar - GBP / USD
Dollar / Swiss Franc - USD / CHF
Dollar / Japanese Yen - USD / JPY

The first currency listed in a currency pair is the reference currency or the base currency. The second currency cross is called the quote currency, or the counter-currency. For example if the EUR/USD is quoted at 1.4050, it means that 1 euro = 1.4050 dollars.

In a forex transaction, the transaction amount is cited in the reference currency, while the result (profit or loss) is expressed in the quote currency.