Foreign Exchange Introduction

There are 180 currencies that are recognized as legal tender around the world today. With so many different ways to pay for goods and services, there is a constant need to convert currencies from one form to another. During the month of January 2016, $4.8 trillion in currency changed hands in global markets on a daily basis, demonstrating the significance foreign exchange plays in our global economy.

1. What is foreign exchange

Foreign exchange is a foreign currency or a means of payment expressed in foreign currency that can be used for international settlement. Article 3 of the regulations on the administration of foreign exchange promulgated in 1996 stipulates the specific contents of foreign exchange as follows: foreign exchange refers to:

① Foreign currency. Including paper money and coinage.

② Foreign currency payment voucher. Including bills, bank payment vouchers, postal savings vouchers, etc.

③ Foreign currency securities. Including government bonds, corporate bonds, stocks, etc.

④ Special drawing rights, European monetary units.

⑤ Other assets denominated in foreign currencies.

2. Foreign Exchange rate and pricing method

Exchange rate, also known as exchange rate, refers to the price of one country’s currency expressed in the currency of another country, or the price ratio between the currencies of the two countries.

In the foreign exchange market, the exchange rate is displayed in five digits, such as:

EUR 0.9705

JPY 119.95

GBP 1.5237

CHF 1.5003

The minimum change unit of exchange rate is one point, that is, the change of the last digit, such as:

EUR 0.0001

JPY 0.01

GBP 0.0001

CHF 0.0001

According to international practice, three English letters are usually used to represent the name of the currency (English code of the currency).

3. Direct price method and indirect price method

There are two kinds of pricing methods of exchange rate: direct pricing method and indirect pricing method.

(1) Direct pricing method

The direct pricing method, also known as the payable pricing method, is to calculate the number of units of domestic currency payable based on the foreign currency of a certain unit (1, 100, 1000, 10000). It is equivalent to calculating the amount of functional currency payable for purchasing a certain unit of foreign currency, so it is called the payable price method. At present, most countries in the world, including China, adopt the direct pricing method. In the international foreign exchange market, the yen, Swiss franc and Canadian dollar are all marked directly, such as 119.05 yen, that is, 119.05 yen per US dollar.

Under the direct pricing method, if the amount of foreign currency converted into local currency of a certain unit is more than that in the previous period, it indicates that the value of foreign currency increases or the value of local currency decreases, which is called the rise of foreign exchange rate; On the contrary, if you want to use less local currency than the original, you can exchange the same amount of foreign currency, which indicates that the value of foreign currency falls or the value of local currency rises, which is called the decline of foreign exchange rate, that is, the value of foreign currency is directly proportional to the rise and fall of exchange rate.

(2) Indirect pricing method

Indirect pricing method is also called receivable pricing method. It is based on the local currency of a certain unit (such as 1 unit) to calculate the foreign currency receivable of several units. In the international foreign exchange market, the euro, pound sterling and Australian dollar are all indirectly priced. If the euro is 0.9705, that is, one euro is 0.9705 US dollars.

In the indirect pricing method, the amount of domestic currency remains unchanged, and the amount of foreign currency changes with the comparison of the value of domestic currency. If a certain amount of local currency can be exchanged for less foreign currency than in the previous period, it indicates that the value of foreign currency increases and the value of local currency decreases, that is, the foreign exchange rate decreases; On the contrary, if a certain amount of local currency can exchange more foreign currencies than in the previous period, it indicates that the value of foreign currency decreases and the value of local currency increases, that is, the foreign exchange rate increases, that is, the value of foreign currency is inversely proportional to the rise and fall of exchange rate.

The quotation in the foreign exchange market is generally a two-way quotation, that is, the bidder shall quote its own buying price and selling price at the same time, and the trading direction shall be determined by the customer. The smaller the difference between the bid price and the ask price, the smaller the cost for investors. The quotation point spread of inter-bank transactions is normally 2-3 points. The quotation point spread of banks (or dealers) to customers varies greatly according to each situation. At present, the quotation point spread of foreign margin transactions is basically 3-5 points, that of Hong Kong forex trading is 6-8 points, and that of domestic banks is 10-40 points.

4. Major global foreign exchange markets

Foreign exchange market refers to the trading market with various currencies as the trading object, which is participated by banks and other financial institutions, proprietary dealers and large multinational enterprises and connected through intermediaries or telecommunications systems. It can be tangible – such as foreign exchange exchanges, or intangible – such as inter-bank foreign exchange transactions traded through telecommunications systems. According to the latest statistics of the bank for International Settlements, the average daily trading volume of the international foreign exchange market is about US $1.5 trillion.

At present, there are more than 30 major foreign exchange markets in the world, which are located in different countries and regions on all continents of the world. According to the traditional geographical division, it can be divided into three parts: Asia, Europe and North America. Among them, the most important ones are London, Frankfurt, Zurich and Paris in Europe, New York and Los Angeles in America, Sydney in Australia, Tokyo, Singapore and Hong Kong in Asia.

Each market has its own fixed and unique characteristics, but all markets have something in common. Each market is separated by distance and time. They are sensitive to each other and independent. After a center closes every day, it passes orders to other centers, sometimes setting the tone for the opening of the next market. These foreign exchange markets take their city as the center and radiate other surrounding countries and regions. Due to the different time zones, each foreign exchange market opens and closes one after another during business hours. They are connected with each other through advanced communication equipment and computer network. Market participants can trade all over the world. The flow of foreign exchange funds is smooth and the exchange rate difference between markets is very small, forming a global integrated operation A unified international foreign exchange market operating around the clock. See the following table for simple information:

Region	City	Opening Time（GMT）	Closing Time（GMT）
Asia	Sydney	11：00	19：00
	Tokyo	12：00	20：00
	Hong Kong	13：00	21：00
Europe	Frankfurt	08：00	16：00
	Paris	08：00	16：00
	London	09：00	17：00
North America	New York	12：00	20：00

5. Foreign exchange market

The foreign exchange platformrefers to the trading place engaged in foreign exchange trading, or the place where various currencies are exchanged with each other. The foreign exchange market exists because:

-Trade and investment

Importers and exporters pay one currency when importing goods and charge another currency when exporting goods. This means that when they close their accounts, they receive and pay in different currencies. Therefore, they need to convert some of the money they receive into money that can be used to buy goods. Similarly, a company that buys foreign assets must pay in the currency of the party, so it needs to convert its domestic currency into the currency of the party.

-Speculation

The exchange rate between the two currencies will change with the change of supply and demand between the two currencies. A trader can make a profit by buying a currency at one exchange rate and selling it at a more favorable exchange rate. Speculation accounts for about the vast majority of transactions in the foreign exchange market.

-Hedge

Due to exchange rate fluctuations between the two related currencies, companies with foreign assets (such as factories) may suffer some risks when converting these assets into the currency of the cost country. When the value of foreign assets denominated in foreign currency remains unchanged for a period of time, if the exchange rate changes, the value of this asset will be translated into domestic currency, which will produce profit and loss. The company can eliminate this potential profit and loss through hedging. This is the execution of a foreign exchange transaction, the result of which just offsets the profit and loss of foreign currency assets caused by exchange rate changes.

6. Major players in the foreign exchange market

Participants in the foreign exchange market mainly include central banks, commercial banks, non bank financial institutions, brokerage companies, dealers and large multinational enterprises. They have frequent transactions and huge transaction amounts, with each transaction in millions of dollars or even more than tens of millions of dollars. Participants in foreign exchange transactions can be divided into investors and speculators according to their trading purposes.

Forex Trading: A Beginner’s Guide

Contents

1. What is the foreign exchange market?
2. A brief history of exchange
3. Foreign exchange market overview
4. Exchange hedging
5. foreign exchange speculation
6. Foreign Trade: A Beginner’s Guide
7. How to start the currency exchange
8. Exchange conditions
9. Foreign Exchange FAQ
10. Advantages and disadvantages of currency exchanges
11. Points out

Foreign exchange is a combination of currency and foreign exchange.Currency exchange is the process of transforming one currency into another (usually through the foreign exchange trading platform) for various reasons. It is usually used for business, commerce, or tourism.According to the Bank for International Settlements (Global Bank of Central Banks) 2019 triennial report, the daily currency trading volume in April 2019 reached US $ 6.6 trillion.

Key points

• The foreign exchange (also known as FX or foreign exchange) market is a global market for the exchange of domestic currencies.
• As trade, commerce and finance spread all over the world, the foreign exchange market is often the largest and most liquid asset market in the world.
• Currencies trade with each other in the form of exchange rate pairs. For example, EUR/USD is a currency pair used to trade the Euro against the U.S. dollar.
• The foreign exchange market exists in the form of a spot (cash) market and a derivative market that provides forwards, futures, options and currency swaps.
• Market participants use foreign exchange to hedge international currency and interest rate risks, speculate on geopolitical events, and diversify investment portfolios for several reasons..

What is the foreign exchange market?

The foreign exchange market is a place where currencies are traded. Currency is important because goods and services can be purchased locally and across borders. Foreign trade and business activities need to be exchanged for international currencies.
If you live in the United States and want to buy cheese from France, you or the company that buys the cheese must pay the French for cheese in Euros (EUR). This means that U.S. importers must convert the equivalent value of U.S. dollars (USD) into euros. The same is true for travel. French tourists in Egypt cannot pay in euros to see the pyramids because it is not a locally accepted currency. Therefore, the tourist must convert the euro to the local currency at the current exchange rate, in this case the Egyptian pound.
A unique aspect of this international market is that there is no central market for foreign exchange transactions. In contrast, currency transactions are conducted through electronic over-the-counter (OTC), which means that all transactions are conducted through a computer network between traders around the world, rather than on a centralized exchange.
The market is open 24 hours a day, 5 and a half days a week, and currencies are traded globally in major financial centers such as London, New York, Tokyo, Zurich, Frankfurt, Hong Kong, Singapore, Paris, and Sydney—in almost every time zone around the world. This means that when the trading day in the United States ends, the foreign exchange markets in Tokyo and Hong Kong will restart. Therefore, the foreign exchange market can be very active at any time of the day, and quotes are constantly changing.

A brief history of foreign exchange

In the most basic sense, the foreign exchange market has existed for centuries. People always exchange or exchange goods and currencies to buy goods and services. However, as we understand today, the foreign exchange market is a relatively modern invention.
After the Bretton Woods Agreement was reached in 1971, more currencies were allowed to float freely. The value of individual currencies varies according to demand and circulation, and is monitored by foreign exchange trading services.
Commercial banks and investment banks conduct most transactions in the foreign exchange market on behalf of their clients, but professional and individual investors also have speculative opportunities to trade one currency with another.
Currency as an asset class has two different characteristics:

• You can earn the interest rate difference between the two currencies.
• You can profit from changes in exchange rates.

An investor can profit from the difference between two interest rates in two different economies by buying currencies with higher interest rates and shorting currencies with lower interest rates. Before the 2008 financial crisis, it was very common to short the yen (JPY) to buy the British pound (GBP) due to the large interest rate differential. This strategy is sometimes called “arbitrage trading . “

Why can we trade currencies

Before the advent of the Internet, it was difficult for individual investors to conduct currency transactions. Most currency traders are large multinational companies, hedge funds or high-net-worth individuals, because foreign exchange transactions require large amounts of capital.

With the help of the Internet, a retail market for individual traders has emerged. Through the establishment of a secondary market by banks or brokers, they can easily enter the foreign exchange market. Most online brokers or dealers provide individual traders with very high leverage, who can control large transactions with a small account balance.

Foreign exchange market overview

The foreign exchange market is where currencies are traded. It is the only truly continuous and uninterrupted trading market in the world. In the past, the foreign exchange market was dominated by institutional companies and large banks that acted on behalf of customers. But in recent years it has become more retail-oriented, and many traders and investors with large holdings have begun to participate.
An interesting aspect of the world foreign exchange market is that there is no physical building as a trading place for the market. Instead, it is a series of connections established through a trading terminal and a computer network. Participants in this market are institutions, investment banks, commercial banks and retail investors.
Compared with other financial markets, the foreign exchange market is considered more opaque. Currency is traded in the over-the-counter market, and disclosure is not mandatory. Large liquidity pools from institutional companies are a common feature of the market. People will assume that the economic parameters of a country should be the most important criterion for determining its price. but it is not the truth. The 2019 survey found that the motivations of large financial institutions played the most important role in determining currency prices.
There are three ways of foreign exchange trading. They are as follows:

Spot market

Foreign exchange transactions in the spot market have always been the largest, because it is the largest “foundation” physical asset for forward and futures market transactions. Previously, the trading volume of futures and forward markets surpassed that of the spot market.
However, with the advent of electronic trading and the proliferation of foreign exchange brokers, the trading volume in the foreign exchange spot market has been boosted. When people refer to the foreign exchange market, they usually refer to the spot market. The forward and futures markets are often more popular with companies that need to hedge foreign exchange risks on a specific date in the future.

How does the spot market work?

The spot market is a place where currencies are bought and sold based on their transaction prices. The price is determined by supply and demand and is calculated based on a number of factors, including current interest rates, economic performance, sentiment about the current political situation (local and international), and views on the future performance of one currency against another.
The final transaction is called a “spot transaction.” It is a bilateral transaction in which one party delivers an agreed amount of currency to the other party and receives a specified amount of another currency at an agreed exchange rate value. After closing the position, it will be settled in cash. Although the spot market is often referred to as a market that processes current (rather than future) transactions, these transactions actually take two days to settle.

Forward and futures markets

A forward contract is a private agreement between two parties to purchase currency in the over-the-counter market at a predetermined price on a future date. A futures contract is a standardized agreement between two parties to deliver currency at a predetermined price on a future date.
Unlike the spot market, the forward and futures markets do not trade real currencies. Instead, the contracts they trade represent requirements for a certain currency type, a specific price per unit, and a future settlement date.
In the forward market, a contract is an over-the-counter sale between two parties, and both parties decide on the terms of the agreement. In the futures market, futures contracts are bought and sold according to the standard size and settlement date of the public commodity market (such as the Chicago Mercantile Exchange).
In the United States, the National Futures Association is responsible for overseeing the futures market. Futures contracts have specific details, including the number of trading units, delivery and settlement dates, and minimum price increments that cannot be customized. As the counter party of traders, the exchange provides clearing and settlement.
Both types of contracts are binding and are usually settled in cash at the relevant exchange when they expire, although the contract can also be bought and sold before expiration. Currency forward and futures markets can provide risk protection when trading currencies. Usually, large international companies use these markets to hedge against future exchange rate fluctuations, but speculators also participate in these markets.
Please note that you will often see the following terms: FX, foreign exchange, foreign exchange market and currency market. These terms are synonyms and refer to the foreign exchange market.

Foreign exchange hedging

Companies that do business abroad face risks due to currency fluctuations when they buy and sell goods and services outside of their domestic markets. The foreign exchange market provides a way to hedge currency risks by fixing the transaction completion rate.
To this end, traders can buy and sell currencies in the forward or swap market in advance to lock in the exchange rate. For example, suppose a company plans to sell American-made blenders in Europe when the exchange rate between the Euro and the U.S. dollar (EUR/USD) is 1 to 1 U.S. dollar.
The manufacturing cost of the blender is US$100, and the American company plans to sell it at a price of 150 euros-which is competitive with other blenders made in Europe. If this plan is successful, the company will get a profit of $50, because the euro/dollar exchange rate is equal. Unfortunately, the U.S. dollar began to appreciate against the euro until the EUR/USD exchange rate was 0.80, which means that the cost of buying 1.00 Euro now is 0.80 U.S. dollars.
The problem the company faces is that although the cost of manufacturing the blender is still US$100, the company can only sell the product at a competitive price of 150 euros, which is only 120 US dollars after conversion (150 euros X 0.80 = 120 US dollars) ). The strengthening of the U.S. dollar caused profits to be much lower than expected.
Blender companies could have reduced this risk by shorting euros and buying dollars at parity. In this way, if the U.S. dollar appreciates, trade profits will offset the reduced profits from the sale of mixers. If the U.S. dollar depreciates, a more favorable exchange rate will increase the profit of selling mixers, thereby offsetting trade losses.
This hedging can be done in the currency futures market. The advantage of traders is that futures contracts are standardized and cleared by central agencies. However, currency futures may not be as liquid as forward markets, which are fragmented and exist in interbank systems around the world.

Foreign exchange speculation

Similar factors such as interest rates, trade flows, tourism, economic strength and geopolitical risks affect the supply and demand of money, which will fluctuate daily in the foreign exchange market. There are opportunities to profit from changes that may increase or decrease the value of one currency compared to another. The prediction that one currency will weaken is basically the same as the assumption that the other currency in the currency pair will strengthen, because currencies are traded in pairs.
Suppose a trader expects that the interest rate in the United States will be higher than that in Australia, and the exchange rate between the two currencies (AUD/USD) is 0.71 (it takes 0.71 USD to buy USD 1.00). Traders believe that rising U.S. interest rates will increase demand for the U.S. dollar, and therefore the AUD/USD exchange rate will fall because fewer U.S. dollars are needed to buy Australian dollars and stronger.
Assuming that the trader is correct and the interest rate rises, this reduces the AUD/USD exchange rate to 0.50. This means that the purchase of AUD 1.00 requires USD 0.50. If investors short-circuit the Australian dollar for a long dollar, they will profit from the change in value.

Forex Trading: A Beginner’s Guide

Trading currencies can be risky and complicated. The degree of supervision of the inter-bank market varies, and foreign exchange instruments are not standardized. In some parts of the world, foreign exchange transactions are almost completely unregulated.
The interbank lending market is made up of banks that trade with each other around the world. The banks themselves must identify and accept sovereign risk and credit risk, and they have established internal processes to ensure their own safety as much as possible. Regulations like this are imposed by the industry to protect every participating bank.
Since each participating bank provides quotations and quotations for specific currencies in the market, the market pricing mechanism is based on supply and demand. Due to such a large transaction flow in the system, it is difficult for rogue traders to influence the price of the currency. The system helps to create market transparency for investors who can conduct inter-bank transactions.
Most small retail traders trade with relatively small and semi-unregulated foreign exchange brokers/dealers who can (and sometimes do) re-quote and even trade with their own clients. Depending on the location of the dealer, there may be some government and industry regulations, but these protective measures are not consistent across the world.
Most retail investors should spend time investigating foreign exchange dealers to find out whether it is regulated in the US or the UK (the US and UK dealers have more regulation), or in a country with lax rules and regulations. It is also a good idea to find out the type of account protection that can be used in the event of market crises or insolvency of dealers.

How to start Forex trading

Foreign exchange trading is similar to stock trading. Here are some steps to get you started on your foreign exchange trading journey.
1. Understanding foreign exchange : Although foreign exchange trading is not complicated, it is a project in itself and requires professional knowledge. For example, the leverage ratio of foreign exchange transactions is higher than that of stocks, and the driving factors of currency price changes are different from the stock market. There are several online courses available for beginners to teach the ins and outs of foreign exchange trading.
2. Set up a brokerage account : You need to open a foreign exchange trading account in a brokerage company to start foreign exchange transactions. Forex brokers do not charge commissions. Instead, they passed the spread between bid and ask prices (also known as point difference) to make money.
For beginner traders, setting up a micro foreign exchange trading account with low capital requirements is a good idea. Such accounts have variable trading limits and allow brokers to limit their trading volume to as low as 1,000 units of currency. For context, the standard account lot size is equal to 100,000 currency units. The micro foreign exchange account will help you adapt to foreign exchange transactions and determine your trading style.
3. Develop a trading strategy: Although it is not always possible to predict and grasp market trends, having a trading strategy will help you develop extensive guidelines and roadmaps for trading. A good trading strategy is based on your actual situation and financial situation. It takes into account the amount of cash you are willing to invest in the transaction, and accordingly the amount of risk you can bear, without depleting your position. Remember, foreign exchange trading is primarily a highly leveraged environment. But it also provides more rewards for those willing to take risks.
4. Always have your numbers: Once you start trading, be sure to check your position at the end of the day. Most trading software already provides daily transaction records. Make sure that you do not have any pending positions that need to be filled, and that you have enough cash in your account for future transactions.
5. Cultivate emotional balance: Forex trading for beginners is full of emotional roller coasters and unanswered questions. Should you continue to hold positions to get more profits? How did you miss the report that low GDP figures have led to a decline in the overall value of your portfolio? Indulging in these unanswered questions can lead you on a chaotic path. This is why it is important not to be fooled by your trading positions and to cultivate an emotional balance between profit and loss. Disciplinary actions will be taken for liquidation when necessary.

Foreign exchange terms

The best way to start a foreign exchange journey is to learn its language. Here are some terms that can help you get started:
Foreign exchange account: A foreign exchange account is an account you use to conduct currency transactions. According to the lot size, there can be three types of foreign exchange accounts:

• Forex micro accounts : Allows you to a transaction worth up to $ 1,000 currency accounts .
• Mini Forex Account : Allows you to a one-time deal worth up to $ 10,000 in currency account .
• Standard Forex Account: Allows you a deal worth up to $ 100,000 of currency accounts .

Remember, the trading limit per lot includes the margin used for leverage. This means that the broker can provide you with funds at a predetermined rate. For example, they might invest $100 in transactions for every dollar you invest, which means you only need to use $10 of your own funds to trade a currency worth $1,000.
Leverage : Leverage is the use of borrowed capital to increase returns. The foreign exchange market is characterized by high leverage, and traders often use these leverages to increase their positions.
For example, a trader may only take out 1,000 US dollars of own capital, borrow 9,000 US dollars from their broker, and bet on the euro (EUR) in a transaction against the Japanese yen (JPY). Since they use very little of their own funds, if the trading direction is correct, traders will make considerable profits. The other side of the highly leveraged environment is that downside risks increase, which can lead to significant losses. In the above example, if the transaction is in the opposite direction, the trader’s loss will increase exponentially.
Spread: Spread is the difference between the buying (selling) price and the selling (buying) price of a currency. Forex traders do not charge commissions; they make money from spreads. The size of the spread is affected by many factors. Some of them are the size of your transaction, the demand for currency and its volatility.
Sniping and hunting : Sniping and hunting are buying and selling currency near a predetermined point to maximize profits. Brokers are obsessed with this practice, and the only way to catch them is to connect with other traders and observe patterns of such activities.

Forex FAQ

What is foreign exchange?

Foreign exchange refers to the exchange of one currency for another currency.

Where is foreign exchange traded?

Foreign exchange transactions are conducted in three places: the spot market, the forward market and the futures market. The spot market is the largest of all three markets because it is the “foundation” asset on which the forward and futures markets are based.

Why do you need to trade forex?

Companies and traders use foreign exchange for two main reasons: speculation and hedging. The former is used by traders to profit from the rise and fall of currency prices, and the latter is used to lock in manufacturing and sales prices in overseas markets.

How do I start Forex trading?

The first step in foreign exchange trading is to let yourself understand the operation and terminology of the market. Next, you need to develop a trading strategy based on your financial situation and risk tolerance. Finally, you should open a brokerage account. For more details, see the section above.

Forex Trading – The pros and cons of trading foreign exchange

Advantages : The foreign exchange market has the largest daily trading volume in the world and therefore provides the most liquidity. This makes it easy to enter and exit positions in any major currency within a fraction of a second with a small spread under most market conditions.
Disadvantages : Banks, brokers and dealers in the foreign exchange market allow high leverage, which means that traders can control a large number of positions with relatively little funds. Leverage in the 100:1 range is not uncommon in foreign exchange. Traders must understand the use of leverage and the risks that leverage brings in the account. Extreme leverage has caused many dealers to unexpectedly go bankrupt.
Advantages : The foreign exchange market trades 24 hours a day, 5 days a week-starting every day in Australia and ending every day in New York. The main centers are Sydney, Hong Kong, Singapore, Tokyo, Frankfurt, Paris, London and New York.
Disadvantages : Effectively trading currencies requires understanding of economic fundamentals and indicators. Currency traders need to have an overall understanding of the economies of various countries and their interconnections in order to grasp the fundamentals that drive the value of currencies.

Forex Trading – The Bottom line

For traders-especially those with limited funds-small day trading or swing trading in the foreign exchange market is easier than other markets. For those with a longer-term perspective and greater capital, trading or arbitrage based on long-term fundamentals may be profitable. Focusing on understanding the macroeconomic fundamentals and technical analysis experience that drive the value of currencies may help new foreign exchange traders become more profitable.