Understand the Basics of Currencies, Foreign Exchange and Forex Trading

Forext Trading For BeginnersIf you’ve ever traveled or done business overseas you’ve almost certainly done a currency exchange in the past. Did you know that you can have your own foreign currency bank a/c and change your money online at rates much better than your bank will give you ?

Here we show you how to target an exchange rate for your foreign exchange just like a professional Forex trader, so that you get the best possible rate, and we take you through all the basics you need to know about currencies and dealer quotes.

When you first begin to deal with foreign currencies some of the terminology can be confusing, not to mention how it all works, so let’s try to make it much clearer.

A currency is simply the type of money which is accepted as legal tender in any particular country. E.g. in the United States it’s the US Dollar, in the UK it’s the Great British Pound, and in the 16 countries of the Euro Zone (e.g. France, Germany, Italy, Spain etc) it’s the Euro.

All of these currencies are “floating” against each other in the international money markets and will rise and fall in value relative to each other, usually as a result of events in international business.

In business terminology foreign exchange is called Forex or FX for short. In the currency exchange markets each currency is known by a unique 3 letter abbreviation. Those which you are likely to see most often are the following;

USD United States Dollar
EUR Euro
GBP Great British Pound
JPY Japanese Yen
CAD Canadian Dollar
AUD Australian Dollar
CHF Swiss Franc
SGD Singapore Dollar
NZD New Zealand Dollar
ZAR South African Rand

Foreign Exchange rates (Changing money from one currency into another)

To begin to understand how foreign exchange rates are quoted and what they mean, let’s begin by looking at a currency exchange transaction you will probably have done at some point in your life.

When you conduct a foreign exchange transaction (e.g. sending money to your folks back home) the dealer you conduct the transaction through will show the value of one currency against another expressed as a BUY rate in a currency pair.

E.g. GBP/USD 1.6543. This exchange rate means that 1 GBP (British pound) will buy $1.6543

Don’t be confused by how many digits appear after the decimal point. This simply allows for very large transactions.

So, for example if you are a UK tourist thinking about your holiday spending money for a trip to the US the above rate will simply mean to you that 1 GBP will buy you $1.65 (We’re looking purely at the currency exchange rate here, and ignoring any fees the dealer may charge).

If you’re planning on doing some serious spending on your trip to the US the above exchange rate means that 1,000 GBP will buy you $1,654.30

Hopefully that’s fairly easy to understand. So, here you’ve been able to see that the first currency shown in a currency pair is always the base currency in that pair, i.e. the pair is showing how much 1 unit of the base currency (GBP in this example) is worth in the other currency (the USD in this case).

If on your return from your trip to the US, you find that you didn’t manage to spend all your US dollars and still have $1,000 left which you want to convert back into GBP, the transaction you now want to do is to Buy GBP by Selling the USD.

So, now you would ask your dealer for a USD/GBP buy exchange rate. i.e. for every 1 US dollar, how many British Pounds will you give me?

If you’re changing money in multiple currencies it’s easiest to think of all transactions in terms of Buy rates as shown above.

Base currency tables

When you visit a foreign exchange counter at a bank you will normally see a display showing various exchange rates against the domestic currency of the country in which your bank branch is situated. For example, in New York a base currency table will show buy and sell rates for all other currencies against the USD.

If a base currency table showed the rates for the JPY to be BUY 94.86 and SELL 95.01 this means;

For every 1 USD you hand over you will buy 94.86 JPYs, and if you want to convert your JPYs back into USDs you simply use the Sell rate, so for every 95.01 JPYs that you SELL to the dealer they will hand you back 1 USD.

Hopefully you can now see why this table is said to have the USD as its base currency, because the rates on the table all show the relationship of the foreign currency (in this example the JPY Japanese Yen) to 1 USD.

You can hopefully also see how this table would really only be useful for people who are only ever buying and selling just the USD against other currencies.

For example, it would be of only limited use to say an Australian business woman who maybe wants to sell Australian dollars (AUDs) in order to purchase goods in the US with USDs, but who receives payment for her services to her Japanese clients in JPYs, and from her local clients in AUDs, and who needs to pay her local staff in AUDs, and who wants to have some EUROs in her pocket for her business trips to Europe !

In her particular life she doesn’t really have one single base currency, as she receives her income in Japanese Yens and Australian Dollars, and spends money in AUDs, USDs and EURs.

So, it will be far more relevant for her to see currency exchange rates expressed as buy rates for AUD/USD or JPY/AUD or AUD/EUR.