Forex: Exchange Rates

Because currencies are traded in pairs and exchanged one against the other when traded, the rate at which they are exchanged is called the exchange rate. The majority of the currencies are traded against the US dollar (USD). The four next-most traded currencies are the Euro (EUR), the Japanese yen (JPY), the British pound sterling (GBP) and the Swiss franc (CHF). These five currencies make up the majority of the market and are called the major currencies or "the Majors". Some sources also include the Australian dollar (AUD) within the group of major currencies.

The first currency in the exchange pair is referred to as the base currency and the second currency as the counter term or quote currency. The counter term or quote currency is thus the numerator in the ratio, and the base currency is the denominator. The value of the base currency (denominator) is always 1. Therefore, the exchange rate tells a buyer how much of the counter term or quote currency must be paid to obtain one unit of the base currency. The exchange rate also tells a seller how much is received in the counter term or quote currency when selling one unit of the base currency. For example, an exchange rate for EUR/USD of 1.2083 specifies to the buyer of euros that 1.2083 USD must be paid to obtain 1 euro.

At any given point, time and place, if an investor buys any currency and immediately sells it - and no change in the exchange rate has occurred - the investor will lose money. The reason for this is that the bid price, which represents how much will be received in the counter or quote currency when selling one unit of the base currency, is always lower than the ask price, which represents how much must be paid in the counter or quote currency when buying one unit of the base currency. For instance, the EUR/USD bid/ask currency rates at your bank may be 1.2015/1.3015, representing a spread of 1000 pips (also called points, one pip = 0.0001), which is very high in comparison to the bid/ask currency rates that online Forex investors commonly encounter, such as 1.2015/1.2020, with a spread of 5 pips. In general, smaller spreads are better for Forex investors since even they require a smaller movement in exchange rates in order to profit from a trade.

Margin
Banks and/or online trading providers need collateral to ensure that the investor can pay in case of a loss. The collateral is called the margin and is also known as minimum security in Forex markets. In practice, it is a deposit to the trader's account that is intended to cover any currency trading losses in the future.
Margin enables private investors to trade in markets that have high minimum units of trading by allowing traders to hold a much larger position than their account value. Margin trading also enhances the rate of profit, but can also enhance the rate of loss if the investor makes the wrong decision.

Leveraged financing
Leveraged financing, i.e., the use of credit, such as a trade purchased on a margin, is very common in Forex. The loan/leveraged in the margined account is collateralized by your initial deposit. This may result in being able to control USD 100,000 for as little as USD 1,000.
There are three ways private investors can trade in Forex directly or indirectly:

.The spot market
.Forwards and futures
.Options