Most investors are very familiar with the workings of the stock market. They are quite simple. You identify a share whose price you think will rise. You then buy a quantity of these shares. When the price rises as expected, you sell these shares, and pocket the difference as a profit.
Forex markets are very similar. You buy a currency whose price you expect to rise, and you sell when you expect it to fall. This is the simple part. The key thing to remember with forex investments, is that each trade requires both a sale and a purchase. Forex investors therefore trade in currency pairs. The examples below explain this further.
In the stock market, you can go to a broker, and buy shares, in say Microsoft. Assume the price is £1 and you buy 100 shares, the trade will cost you £100. You have therefore exchanged £100 and received 100 Microsoft shares in exchange. The key thing to remember here is that the prices are quoted in £ per share.
A similar trade can occur in forex markets. The chief distinction is that by trading currencies, you are trading money, in exchange for money. Assume that the US$ and the £ are trading at 2:1, i.e. it will cost you $2 for every £1. If you expect the dollar to strengthen against the pound (i.e.. less dollars for each pound), you buy dollars, and sell pounds. In simple terms, you would buy $100, and in exchange, give (or sell) £50. When the dollar appreciates against the pound, you would then sell the $100, for (say) £60 in exchange, making £10 profit.
The distinction between the two, is that in a given market, stocks and shares are quoted and traded in a single currency. Therefore, any prices quoted are absolute. An increase in price is an increase in price.
In a forex markets, the prices are quoted in terms of other currencies. It is therefore possible for one currency to be strengthening against a second, while simultaneously weakening against a third. Therefore, currencies to do not rise in value in the absolute. They rise and fall in price relative to a second currency. The dollar does not just rise in value. It rises in value against another currency.
Extending the example above. The $/£ price might be 2:1. At the same time, the dollar/Euro price might be 1.5:1. As the forex markets operate, you might see the $/£ move to 1.9:1. In this instance the dollar has strengthened against the pound. Simultaneously, the dollar/Euro price might move to 1.6:1. This means that the dollar has weakened against the Euro at the same time that it has strengthened against the pound. The movements will also have implications for the pound/Euro price, but that is beyond the scope of this article.
If you had bought dollars, and sold (exchanged) pounds, you would have made a profit. If instead you had bought dollars and sold (exchanged) Euros, you would have made a loss.
This trading of currencies in pairs on the forex markets is their chief difference from the traditional stock markets. Thus, you will always find currency price quotations in pairs, e.g. USD/GBP (dollar/pound), USD/EUR (dollar/Euro), USD/JPY (dollar/yen).
No related posts.
Related posts brought to you by Yet Another Related Posts Plugin.
