The foreign exchange market is one of the largest
in the world if not the largest. 9 billion, more than 3 times larger than the
stock/equities market and more than 5 times bigger than futures, give Forex
traders nearly unlimited liquidity and flexibility. It has been estimated that
approximately $2 trillion USD of currency exchanges hands each and every day.
The world’s currencies are on a floating exchange
rate and are always traded in pairs, for example EUR/USD or USD/JPY or USD/INR.
The Forex currency pair is a single unit, an instrument that is bought or sold
in the Forex market. Each currency pair is expressed in units of the counter
currency needed to get one unit of the base currency
The first currency is called the base currency and
the second listed currency is called the quote or counter currency. The base
currency is the basis for the buy or sell transaction. For example if you place
a BUY order in the EURO/USD pair you are effectively buying EURO dollars and
selling US Dollars.
Interest rates are due to fall in the US and
therefore you believe the Euro will appreciate due to the European Union having
higher interest rates. Therefore in order to take advantage of this and make a
bet against the US dollar you would BUY EURO/USD. This buy order effectively is
buying EURO dollars and selling US Dollars.
Alternatively if you think the EURO dollars will
fall due to economic problems such as high inflation and increasing unemployment
and want to make a trade that the EURO dollars will fall against the US dollar
you would need to SELL the EURO/USD currency pair. This sell order also referred to as
GOING SHORT effectively is selling EURO dollars and buying US dollars.
Therefore in summary:
BUY EURO/USD (Long the EURO) – Buy EURO Selling USD
Assumption EURO to appreciate against the USD
SELL EURO/USD (Short the EURO) – Sell EURO Buy USD
Assumption USD to appreciate against the EURO.
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