Forex is a commonly used abbreviation for foreign exchange, even if there is no central marketplace for the forex markets, we can describe the forex markets as the place where currencies are traded. So the question is, why do people trade currencies? There are so many reasons behind it and we will see some of them.
But for now, let’s have a look at some normal people who don’t even know the existence of the forex markets. Mr. Johnson is an American guy on a trip to Italy, and he needs to exchange his dollars into euros. When he does that, he essentially participates in the forex market. He has exchanged one currency for another or in forex terms. So we say he sold the US dollars and he bought euros. After visiting Italy, he stops at the exchange booth at the airport to exchange back the euros that he has left over. So he makes a forex transaction once again. This is just an example based on a single person.
But think of a big company like Apple that needs to buy goods in Japan, for example, and so it needs to exchange millions of dollars into yen. So quite a big transaction. So it is necessary to exchange currencies. This is the primary reason for the existence of the forex market. And it also explains why the forex market is the largest and most liquid financial market in the world, about 25 times bigger than the stock market, with around five trillion dollars transactions per day on average against the 200 billion dollars that we count in the stock market.
When you trade the forex markets because you are not buying anything physical, it can be confusing. So here is my advice. Think of buying a currency as buying a share in a particular country, just like buying the stocks of a company. Why do I say this? Because the price of the currency is usually a reflection of the health of that country’s economy.
When you buy stocks of a company, let’s say Apple, it is because you believe that Apple is a good company and will continue to be good in the future. So you invest in it with the expectation that with the company’s growth, the price of the share will grow as well. So you can sell it at a higher price in the future and realize a profit in the forex markets.
When you buy, let’s say, the Australian dollar, you are basically buying a share in the Australian economy. You are investing in the Australian economy because you believe that it is doing well and it will continue like that in the future. So you have the expectation that in the future you can sell that share of Australian economy at a higher price, realising a profit. Here we have the so-called major currencies. Currencies symbols always have three letters where usually the first two letters identify the name of the country and the further letter identifies the name of that country’s currency.
So USD stands for the United States dollar and GBP stands for Great Britain pounds. But it is not always like this. For example, the symbol of the euro is the EUR and of course it stands for euro. Why do we call them major currencies? It is simply because they are the most traded ones. So there are many transactions on them every single day and you will see them many times in your trading career.
We have already seen how some currencies are considered majors and some others are considered minors. Now that we have learned that currencies are traded in pairs. It’s time to learn which currency pairs are considered majors and which ones are considered minors. The currency pairs that you see here are considered majors. One of the first things that you can notice is that all of these pairs contain the U.S. dollar on one side and another major currency on the other side going very quickly through them.
Bears are the most liquid and widely traded currency pairs in the world. We will see why it is an advantage to trade currency pairs with high liquidity and high volume. As you can see, I also ordered a kind of nickname because sometimes you will see traders calling the currency pairs with their nickname. So if you are reading a book or a blog and the author says the cable is a very interesting currency pair, you will know that he is talking about the pound dollar exchange. Then we have currency pairs that do not contain the U.S. dollar, but they contain other two major currencies and they are known as cross-currency pairs. Or you can just simply call them across as these crosses are also known as minors.
So, for example, we have a euro against the British pound or British pound against Japanese yen or Swiss franc, against Australian dollar and so on. Like this. All these pairs are examples of minors because they contain the two major currencies, but not the U.S. dollar. Then we also have exotic currency pairs and they are made up of one major currency pair with the currency of an emerging economy such as Brazil or South Africa or Norway. The U.S. dollar against the Danish krone, and it is an example of exotic PR. So you have a lot of currency pairs that you can trade.
But my suggestion is to focus on the majors at the moment. As I said, majors tend to be very liquid currency pairs with high volumes, which offers a source of protection against sudden spikes or spread widening. You will understand it better later on for the time being. If you want to start to have a look at how some currency pairs behave, I suggest you to focus on the majors. If you want to go a little further, maybe you can include the miners, but I will definitely exclude exotic currency pairs from my watch list.