Currency Exchange Rates
If you have only recently started trading the foreign exchange markets, your view of the importance of forex exchange rates has surely changed drastically. To be more specific, you now know how incredibly important currency exchange rates really are, not only to forex traders such as yourself, but to banks, countries, and people.
If you’ve been trading forex online for a while, remembering this change in perspective --the recalling of the day you realized how important currency exchange rates are -- may not be as fresh in your mind. But no doubt you experienced a similar epiphany:
Currency exchange rates might be the single most important piece of economic data in the world today. In the global economy, the impact of currency exchange rates is unbelievably huge.
Why Forex Traders Need to Know About Currency Exchange Rates
Obviously, forex traders need to know much more about currency exchange rates than the Average Joe because when you’re trading forex, you’re trading currency exchange rates. You’re trading the exchange rate of one currency versus another.
When starting out trading currencies, this is one of the most difficult mental hurdles to overcome, this idea that you’re investing in the relationship of one currency to another, rather than investing in one currency and not another.
For example, if you purchase the USD/JPY at 92.33, you have not bought the U.S. dollar and sold the Japanese yen so much as you have bought that 92.33 ratio of USD to JPY.
Yes the reality can be expressed as buying the dollar and selling the yen, but technically speaking, your investment--your “asset”--is that 92.33 number, that 92.33 ratio of USD divided by JPY.
This may seem like splitting hairs, but the concept is an essential one to master: when you’re trading FX, you’re trading currency exchange rates.
How Currency Exchange Rates Are Measured In the Forex Markets
Theory is worthless without consideration of the practical side of the matter. In order to make money trading currencies, you must develop a thorough understanding of how currency exchange rates are expressed in the real world of forex trading.
-- The first currency is called the “base currency,” and the second currency is called the “counter currency.” Divide the base by the counter and you get the currency exchange rate. Yes, the computer will do that math for you, but you still need to know that math.
-- The small units of currency exchange rate fluctuations are called “pips.” For example, when the EUR/USD goes from 1.4543 to 1.4540, the EUR/USD has declined three pips.
-- Many forex brokers now use what’s called “fifth digit pricing.” In essence, these brokers divide pips into even smaller increments of price movement. Although this may provide you with a more precise price, fifth digit pricing can be extremely confusing at first, making you think that prices are moving faster and more drastically than they really are. (You can turn off the fifth digit pricing setting if you like; many forex pros do.)
Factors That Affect Currency Exchange Rates
Like everything else in the financial markets, currency exchange rates are dictated by the law of supply and demand. How many people want how much of one country’s currency determines that currency’s value--that’s a simplification but it’s still a truth.
There are numerous factors that affect both the supply and the demand of certain currencies, and thus affect currency exchange rates. Three giant factors are:
-- Interest rates
-- Economic conditions
Forex authors go into hundreds of pages of detail as to how each of these factors affect currency exchange rates. That’s not possible in this short article.
But rest assured that interest rates, economic conditions, and confidence are always, always, always playing major roles in the supply-demand situation of currency exchange rates. No FX trade is complete without consideration of these three factors.
This Is a Global Market, So Think Big
When trading with a currency trading broker, a failure to think big can be a really, really big failure. The challenge of deciphering global trends is probably the most exhilarating part of trading foreign currencies. This truly is the 800,000 pound gorilla of the financial markets.
Even if you’re just trading a demo or a micro account, you must constantly be on the lookout for “macro” changes that can completely change currency exchange rates.
These humongous changes are out there lurking, and many will likely come to fruition within the next few years. Some possibilities:
-- The U.S. dollar could cease to be the “reserve currency” of choice. That is, banks and governments could stop stockpiling dollars as protection, and start stockpiling some other currency as protection, or even a commodity (gold, grain). If the U.S. dollar were to lose its place as the reserve currency of choice, the impact on all currency pairs involving the dollar would be absolutely ginormous. Dollars would be much less in demand.
-- Along the same lines: for decades, oil has been denominated in U.S. dollars. That is, the price for oil has been quoted in U.S. dollars and in order to buy oil, it has been necessary to take into account the U.S. dollar. China and Russia no longer particularly like this arrangement. The price of oil may not always be quoted in U.S. dollars.
-- On the flipside, what if the U.S. economy recovers robustly? What if all the doomsayers are dead wrong, and the U.S. dollar is a sleeping giant? That’s macro, too.
Of course there are many other global events that could quite literally change everything with respect to currency exchange rates. The point here is that if you can expand your mind while trading forex, you may well be able to expand your wallet as well.
Currency exchange rates are a big deal in every sense of the phrase.
Important Forex Information
The most important step in currency trading is finding the right broker; our forex experts can help. See our
reviews of forex brokers for more information.
Foreign currency exchange trading is the practice of trading x for y in hopes that the value of y will increase. Learn the basics of foreign currency exchange rates.
There are many excellent foreign exchange calculators available for free on the Internet. Let us tell you how to choose a currency exchange calculator.
Unfortunately, far too many beginning traders start trading FX without spending the time to gain necessary knowledge. Find out what you must know about exchange rates.