Foreign Exchange Basics

Foreign Currency Trading

The FX market, also called the spot market, allows you to trade currency pairs that offer equal risk for selling and buying a currency. The two currencies in a pair have an inverse relationship, such that when one goes up, the other goes down. This means trading opportunities abound by buying into a currency when it goes up, or selling it when it goes down.**

The following explanation incorporates some terms highlighted in italics. These terms are here to help you get familiarize with the FX market.

For example, when you are entering in a long position on EUR/USD, this means that you are going to buy the Euro (EUR) and sell the US Dollar (USD), and it works the same way when you enter a short position on EUR/USD, in which you are actually going sell Euro and buy the US Dollar.

In the currency pair, the first currency symbol is known as the Base Currency. It is always the dominant of the two symbols, and drives the direction of a trade. The second symbol is called the Cross Currency. It fluctuates in exchange rate value compared to the Base Currency.

For example, with the EUR/USD pair, the Euro is the Base Currency and the US Dollar is the Cross Currency. If the Base Currency is stronger in value than the Cross Currency, the trade will have an upward trend for a specific time interval. Conversely, a downward trend is indicated if the Base Currency is weaker than the Cross Currency.

There are six major currency pairs containing the USD that make up significant trading volume on a daily basis. They are:

EUR/USD - Euro vs. US Dollar
USD/CHF - US Dollar vs. Swiss Franc
GBP/USD - Great Britain Pound vs. US Dollar
USD/JPY - US Dollar vs. Japanese Yen
USD/CAD - US Dollar vs. Canadian Dollar
AUD/USD - Australian Dollar vs. US Dollar

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Brief History of FX Market

In case you were wondering, foreign exchange dates back to ancient times, when traders first began exchanging coins from different countries and groups. However, the foreign exchange industry itself is the newest of the financial markets.

In the last hundred years, the foreign exchange market has undergone some dramatic transformations.

In 1944, the postwar foreign exchange system was established as a result of a multinational conference held at Bretton Woods, New Hampshire. At this conference, representatives from 45 nations met together to discuss the future exchange system. The conference resulted in the formation of the International Monetary Fund (IMF). It also produced an agreement that fixed currencies in an exchange-rate system would tolerate one percent currency fluctuations to gold values, or to the U.S. Dollar, which was established previously as the "gold standard." The system of connecting the currency's value to gold or the U.S. Dollar was called pegging. That system remained intact until the early 1970's.

In 1971, the Bretton Woods Accord was first tested because of dramatically uncontrollable currency rate fluctuations. This started a chain reaction, and by 1973, the gold standard was abandoned by President Richard Nixon. The fixed-rate system collapsed under heavy market pressures, and currencies finally were allowed to float freely.

The foreign exchange markets officially switched to a free-floating market after the double demise of the Smithsonian Agreement and the European Joint Float. This switch occurred more due to lack of any other available options, but it is important to understand that the free floating of currency was not, by any mean, imposed. This means that countries were free to peg, semipeg, or free-float their currencies.

Free-Floating: When the major currencies are free-floating, such as the U.S. Dollar, they move independently of other currencies. The value of the currency is determined by supply and demand, which has no specific intervention point that has to be observed, and can be traded by anybody so inclined. Free-floating currencies are in the heaviest trading demand.

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**All DIMEFX instructional materials have been put together in good faith. We believe them to be accurate but do not guarantee, explicitly, or implicitly, that all of the material is accurate in every respect. By using DIMEFX and/or DIME Financial Group LLC material, you agree to all the terms herein. None of the materials may be duplicated, distributed, reproduced or commercially used without written consent from DIME Financial Group LLC.

It is essential that a Demo simulator account is used first THOROUGHLY before commencing with a Live Online Forex account. The trading system is strictly for the use by traders with EXCESS RISK CAPITAL and who are fully aware of the inherent risks involved in Forex trading. The high degree of volatility within the foreign exchange market, and the ability to leverage your position means that losses can be quick and significant. You may lose your entire investment capital. It is your responsibility to ensure that you fully understand these conditions before proceeding further. Past results are not a guarantee of future results for trading any type of bonds, equities, or Forex.