14. What is Forex trading/ FX Trading?
What is Forex trading?
Forex is the short form of “foreign exchange”.
Forex trading, so-called FX trading, refers to transactions of foreign currency.
International trade requires a considerable amount of foreign currency for settlement.
“Forex” also means the foreign currency used as an international settlement.
A forex transaction involves exchanging one currency to another, and the rate between the two is the exchange rate.
For example:
the exchange rate of USD/JPY is 100, which means that a dollar holder can exchange 100 yen for each dollar based on this price quote.
This is regardless of the bid-ask spread and handling fees.
Conversely, holders of the Japanese Yen can get 1 dollar by paying 100 yen, to complete a transaction.
Forex price quotes are in “pairs”
In the forex trading markets, there are quotations of currencies issued by all countries in the world (exchange rates), typically quoted in a pair, also called currency pairs. Common currency pairs include:
- EUR/USD
- USD/CAD
- AUD/JPY
- EUR/GBP
Most of which are real-time reference quotes of various currencies currently exchangeable with different currencies. Since there are more than 100 currencies globally, this means that there can be as many as tens of thousands of quotation combinations.
Related Article: What are the major currencies?
How forex quotation works
The quotation system in the forex market is centered on the “US dollar”. Each currency takes the US dollar as the basis of exchange. All exchange rates with the US dollar can be “inter-converted” into all other exchange rates. There is no error (price differential) in this conversion.
Even if there was, it will be quickly adjusted by the market due to arbitrage.
For example, EUR/USD=1.5 and GBP/USD =1 means that 1 EUR can be exchanged for 1.5 USD and 1 GBP for 1 USD, so the exchange rate of EUR/GBP can be calculated as 1.5. When the EUR/USD rises to 2 and the GBP/USD rises to 1.6, the exchange rate of EUR/GBP will be adjusted to 1.25, provided that the US dollar depreciates against both currency at the same time. This represents a drop of 1 EUR from 1.5 GBP to 1.25 GBP.
It is important to note that the meaning behind the so-called currency pairs also points out that forex trading and transactions are essentially based on the relative value of two currencies rather than a measurement of the absolute value of a single asset.
For example:
the appreciation of the US dollar normally means the US dollar appreciates against all other currencies.
However, the degree of appreciation will vary due to different factors. On the other hand, even if the overall value of the US dollar remains the same when other currencies appreciate, the dollar depreciates on a relative basis.
In addition, in the USD/JPY example above, it can be seen that forex trading is also in a pair. As holders of the US dollar trade for yen, in effect, the counterparties who hold yen also trade for dollar relatively. So, one side buys yen and sells dollars, and the other side buys dollars and sells yen. In terms of investment and trading without actual needs, forex trading also represents the prediction of both sides on the future price trend of the currencies.
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Risk Warning: The above content is for reference only and does not represent ZFX’s position. ZFX does not assume any form of loss caused by any trading operations conducted by this article. Please be firm in your thinking and do the corresponding risk control.