What is FOREX?

FOREX (FOReign EXchange Market)

The Foreign Exchange Market is the arena where a nation's currency is exchanged for that of another at a mutually agreed rate. The FOREX market was formed in the mid ‘70s, when international trade was changed from a system of fixed rates to a system of free-floating rates of exchange.

In fact, every country’s currency is considered merchandise, like wheat or sugar; it is the same medium of exchange, like gold and silver. Since the world changes faster and faster every year, the economic conditions of every country (e.g. labor productivity, inflation, unemployment, etc.) are ever more dependant upon the level of development of other countries, and this, in turn, impacts the value of a country’s currency in relation to the currencies of other countries. This is the main reason why there are rate fluctuations.

Currency Symbols:

Table 1

Currency Exchange Rate

Currency exchange rates are simply the ratio of one currency valued against another. For example, "EUR/USD exchange rate is 1.2505" means that one euro is traded for 1.2505 dollars.

The exchange rate of any currency is usually given as a bid price (left) and an ask price (right).

The bid price represents what has to be obtained in the quote currency (US Dollar, in our example) when selling one unit of the base currency (Euro, in our example).

The ask price represents what has to be paid in the quote currency (US Dollar, in our example) to obtain one unit of the base currency (Euro, in our example).

The difference between the bid and the ask price is referred to as the spread.

Table 2

Let's assume the exchange rate for EUR/USD is: 1.2505/1.2509. You may have done some market analysis and decide the EUR/USD rate is moving higher (at least to 1.2600) so you buy 0.1 lot (minimum contract size) of EUR/USD at the 1.2509 ask price.

Table 1 will help you define what the contract size is, i.e. 1.0 lot for EUR/USD is 100,000 EUR so 0.1 lot (our contract size) is 10,000 EUR.

This means you bought 10,000 EUR and sold 10,000 * 1.2509 = 12,509 USD.

Now, in order to make a trade, you don't need to have the total amount of $12,509. You actually require just 1/100th of that amount ($125.09) as the rest of the money (in our example, $12,383.91) is leveraged to you by a broker (a company you entered the contract with to enter the market).

Leverage

Leverage is the term used to describe margin requirements - the ratio between the collateral and borrowed funds i.e. 1:20, 1:40, 1:50, 1:100. Leverage 1:100 means that when you wish to open a new position, you only deposit 1/100th of the contract size.