When trading currencies at a forex broker online, you find the currencies listed as pairs, e.g. EUR/USD, USD/JPY and GBP/USD.
Any listed pair will also have a number next to it. For example: GBP/USD 1.2133. This means that if you can buy 1 GBP for 1.2133 USD.
The first currency in the pair is called the base currency, and the other one is the quote currency.
If the USD increases in value in relation to the GBP, the number will go down, as you will pay less and less USD to obtain 1 GBP. If the USD decreases in value in relation to the BGP, the number will go up, as you will be paying more to acquire 1 GBP.
What are crosses?
Currency pairs that do not include the USD are referred to as crosses. The most heavily traded crosses are EUR/GBP and EUR/YEN. The EUR/GBP is the 10th most heavily traded currency pair in the world.
On the forex market, currencies are normally traded in lots. In addition to standard-size lots, there are mini, micro, and nano lots. Most beginner-friendly retail forex trading platforms offer mini, micro, and nano lots.
A standard lot is 100,000 units of currency. A mini lot is 10,000 units, a micro lot is 1,000 units, and a nano lot is 100 units.
Which currencies should I trade?
If you are a beginner, it is advisable to pick one currency pair and specialize in that one. Do not branch out to more than one currency pair until you are long-term profitable with that pair. Spreading oneself too thin and jumping on every perceived “good opportunity” to trade is a common beginner mistake and is usually quite costly in the long run.
Generally speaking, beginners are advised to stick to currency pairs where the liquidity is high since this reduces the risk of slippage.
So, which are currencies with the highest liquidity? In 20201, the top five traded currencies were USD, EUR, JPY, GBP, and AUD. Together, they made up a very larger chunk of the total forex market. Following them on the top-10 list were CAD, CHF, CNY, SEK, and NZD.
The United States dollar (USD). The USD is by far the most traded currency on the forex market and is part of almost all of the top-10 traded currency pairs, with EUR/GBP being the exception. The USD is issued by the US Federal Reserve. Despite not being a multi-nation currency like the Euro, the United States dollar is still utilized for transactions in many different parts of the world. The currency reserves of nations tend to be heavily comprised of USD.
The euro (EUR). The Euro is the official currency of 19 of the European Union’s 27 member states. The Euro’s share of global forex trade is predicted to rise even higher in the future if more of the member states adopt it as their currency. The Eurozone, also known as the Euro area, is comprised of 19 EU members that have adopted the Euro as their primary currency and sole legal tender. The monetary authority of the Eurozone is the Eurosystem. The European single market is larger than the Eurozone, as it comprises all the 27 member states of the European Union. With certain exceptions, the non-EU states Iceland, Norway, Liechtenstein, and Switzerland are also included in the single market. The Euro is the second-largest reserve currency in the world.
The Japanese yen (JPY). The Japanese yen is an important currency in the forex market because Japan is a major exporter of consumer goods. It is the third-most exchanged currency in the world. The Japanese yen is the third-largest reserve currency but still accounts for less than 5% of the global currency reserves. The Japanese economy is characterized by very low-interest rates, low national debt, and a large trade surplus.
The sterling (GBP). The sterling is the official currency of the United Kingdom and its associated territories. The pound (sign: £) is the main unit of sterling, and the currency is often unofficially referred to as pound sterling or the British pound. The ISO code for the currency is GBP. Sterling is issued by the Bank of England. While the sterling is not the most traded currency in the world, London is the world’s largest trading centre for forex. During an average day, the London trading session is responsible for over 40% of the total daily volume.
The Australian dollar (AUD). The Australian dollar (AUD) is the official currency of Australia and is also used by certain territories with ties to Australia that do not have their own monetary and fiscal system. The Australian dollar is issued by The Reserve Bank of Australia. Among forex traders, it is known as a so-called commodity-based currency since the value of the AUD is strongly correlated to Australia’s export of commodities, such as coal and iron ore. Global demand for those commodities will therefore impact the value of the AUD. (Another example of a commodity-based currency is the Canadian dollar.) On an average trading day, the AUD accounts for circa 6.8% of the global forex trading volume.
Forex spot trading
For spot trading, the price is agreed on the trade date, but money is exchanged on the value date when the transaction is settled.
For most currencies, spot trading entails settling in two business days (T +2). The USD/CAD currency pair is an important exception, which settles on the next business day (T+ 1).
Since only business days count, holidays such as Christmas and New Year can cause situations where a date that is two business days away is simultaneously several calendar days away.
The forex forward market
A forex trade that will be settled further into the future than a forex spot trade is called a forex forward trade.
The forward price is based on the spot rate and so-called forward points. The forward points represent the interest rate differential between the two currencies, and forward points can therefore be positive or negative.
In theory, beginning forex traders should know that a forex forward can be created with a settlement date very far into the future; but in reality, this is very uncommon, and most forex forwards are created with a settlement date that is less than a year into the future.
Forex forwards are not standardized.
Forex futures settle later than spot contracts and can therefore be seen as a type of forwards. But while forex forwards is non-standardized, the forex futures are highly standardized and ideal for speculation.
Another example of a forex derivative is the forex option. Forex options are based on currency pairs, and there are several different types of forex options to choose from. The price you pay when you purchase an option is called the premium.
Forex options are almost always non-delivery, meaning they can only be cash-settled. A non-delivery option does not give you any right to actually receive the currency (e.g. 500,000 Canadian dollars) – they are only used for speculation, hedging and similar.
Just like other options (e.g. stock options), forex options are only binding for the issuer. The owner of the option has no obligation.
The two most common varieties of forex options are the vanilla options and the SPOT options.
Vanilla forex option
This is the traditional and most common form of forex option.
- A vanilla forex call option gives the owner the right (but not any obligation) to buy the stated amount of the stated currency from the issuer of the option, upon expiration, by paying the strike price. (If the option is a non-delivery option, the affair will be cash settled.)
- Vanilla forex put option gives the owner the right (but not any obligation) to sell the stated amount of the stated currency upon expiration and receive the strike price from the issuer of the option. (If the option is a non-delivery option, the affair will be cash settled.)
What is a currency ETF?
ETF is short for Exchange-traded fund. An exchange-traded fund is a pooled investment fund where the shares are listed on an exchange. It is, therefore, very easy to buy and sell the shares, and you can keep an eye on how the market values the fund. Practically, buying and selling ETF shares is similar to buying and selling exchange-traded company shares.
A currency ETF is an ETF specializing in currency trade. It is also known as a forex ETF.
Buying shares in an ETF can therefore give you exposure to the forex market without you actually having to do the forex trading.
- Most, but not all, currency ETFs are passively managed.
- A currency ETF can gain exposure to exchange-rate changes in a variety of ways, such as spot trading, short-term debt denominated in a specific currency, and forex derivative trading.
- Some currency ETFs are “guaranteed” by foreign currency bank deposits.
Examples of currency ETFs
- WisdomTree Bloomberg U.S. Dollar Bullish Fund
- WisdomTree Chinese Yuan Strategy Fund
- WisdomTree Emerging Currency Strategy Fund
- iPath® GBP/USD Exchange Rate ETN
- iPath® JPY/USD Exchange Rate ETN
- ProShares Bitcoin Strategy ETF
- Invesco CurrencyShares Euro Trust
- Invesco CurrencyShares Canadian Dollar
- Invesco CurrencyShares Japanese Yen
- Invesco CcyShrs® British Pound Sterling
- Invesco CurrencyShares Swiss Franc
- Invesco CcyShrs® Australian Dollar
- Invesco DB US Dollar Index Bullish Fund
- Invesco DB US Dollar Index Bearish Fund
- Invesco DB G10 Currency Harvest Fund
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