The foreign exchange market is the "place" where currencies are traded. Currencies are important to most people around the world, whether they realize it or not, because currencies need to be exchanged in order to conduct foreign trade and business. If you are living in the U.S. and want to buy cheese from France, either you or the company that you buy the cheese from has to pay the French for the cheese in euros (EUR). This means that the U.S. importer would have to exchange the equivalent value of U.S. dollars (USD) into euros. The same goes for traveling. A French tourist in Egypt can't pay in euros to see the pyramids because it's not the locally accepted currency. As such, the tourist has to exchange the euros for the local currency, in this case the Egyptian pound, at the current exchange rate.
Welcome to the World of Currencies
What is Foreign Exchange? The exchange of one country’s currency for currency of another country is called Foreign Exchange. The foreign exchange market is the "place" where currencies are traded.
When companies conduct business across borders, they must deal in foreign currencies . Companies must exchange foreign currencies for home currencies when dealing with receivables, and vice versa for payables. This is done at the current exchange rate between the two countries. Currencies are important to most people around the world, whether they realize it or not, because currencies need to be exchanged in order to conduct foreign trade and business An Indian Exporter will receive funds in the Foreign currency and would want to exchange the same in to rupees
The need to exchange currencies is the primary reason why the forex market is the largest, most liquid financial market in the world. It dwarfs other markets in size, even the stock market in terms of volumes.
3,000,000,000,000 That’s a mind-boggling number, isn’t it?
Getting inside the numbers Average daily currency trading volumes exceed $3 trillion per day To give you some perspective on that size, it’s about 10 to 15 times the size of daily trading volume on all the world’s stock markets combined
It’s a 24 hour market The market is open 24 hours a day, five and a half days a week, and currencies are traded worldwide in the major financial centers of London, New York, Tokyo, Zurich, Frankfurt, Hong Kong, Singapore, Paris and Sydney - across almost every time zone. This means that when the trading day in the U.S. ends, the forex market begins anew in Tokyo and Hong Kong. As such, the forex market can be extremely active any time of the day, with price quotes changing constantly. Trading time in India is from 9:00 Am to 5:00 Pm
Buying and Selling Simultaneously In the currency market, a currency trade consists of a simultaneous purchase and sale. In the stock market, for instance, if you buy 100 shares of Tata motors, you own 100 shares and hope to see the price go up. When you want to exit that position, you simply sell what you bought earlier
But in currencies, the purchase of one currency involves the simultaneous sale of another currency. This is the exchange in foreign exchange. To put it another way, if you’re looking for the dollar to go higher, the question is “Higher against what?” The answer is another currency. In relative terms, if the dollar goes up against another currency, that other currency also has gone down against the dollar Currencies come in pairs
Currencies Come In Pairs
Currencies come in pairs To make matters easier, forex markets refer to trading currencies by pairs, with names that combine the two different currencies being traded or “exchanged” against each other Let’s look at some common pairs –
Base currency/Term currency In foreign exchange markets, the base currency is the first currency in a currency pair. The second currency is called as the terms currency. Exchange rates are quoted in per unit of the base currency Let’s take an example: Here the Rupee is being quoted against the Dollar. The Dollar is the Base currency and the Rupee is Terms currency. The USD is the currency being priced and the Rupee is the currency which is used to express the price
Let’s do an exercise: Can you identify which is the Base Currency in the below example? Here the USD is the Base currency and the GBP is the terms currency Always remember that the Base currency is always quoted first