Foreign Currency Trading Markets - More Information

The most active currency exchange rates (like the EUR/USD and USD/JPY) can change up to 18,000 a day by some estimates. This shows the tremendous liquidity and depth of the currency trading market.

Currencies are being traded every moment of the day. Somewhere around the world one or more financial centers are opened for business. Banks and other institutions are constantly trading the dollar, euro and other foreign currencies. Whether in Tokyo or New York, currencies traders are clicking their computer keyboards to buy or sell foreign currencies.

Around the world, trading hours overlap, as some financial centers close and others open for business. Trading takes place in New York, London, Hong Kong, Singapore, Frankfurt, Tokyo, and many other financial centers. These financial centers are linked to one another in a unified market, so at any given time one or more financial centers are open for currency trading.

The chart below indicates the currency trading activity during the day throughout the business hours that each financial center is open for business.

1. The Currency Spot Market

A currency spot trade is the most popular foreign currency transaction in the world. The spot rate is the current market price or cash rate for a currency pair. A spot transaction consists of an agreement whereby a party delivers a specified amount of a given currency against receipt of a specified amount of another currency from the counterparty, based on an agreed exchange rate, within two business days of the date of the transaction. The exception of the two-day settlement rule is for Canadian dollar, for which the spot delivery takes place the next business day.

2. Bid and Ask

When trading currencies, the trader encounters two prices: a bid and an ask. This is the same as in stocks and futures. The "bid" is the price a bank or market maker is willing to pay for the currency in question. The "ask" is the price at which the market maker or bank is willing to sell the currency. The online currency trader could thus, buy from the bank or market maker at the "ask" and sell at the "bid."

The difference between the bid and ask price in currency trading is called the spread. The more liquid or active a market is, the lower the spread. Since level of liquidity in the major currencies like the EUR/USD, USD/JPY, GBP/USD, and USD/CHF, is so great, the spreads are very tight. Consequently, transactions occur every few seconds and there is always a buyer for every seller. For more information on Bid and Ask, read "How to read a currency quote."

3. Currency Quotes - Base Currency and Counter Currency

A currency trade or foreign exchange transaction involves two currencies: the base currency and counter currency. In a currency quote the base currency is displayed first followed by the counter currency; for example, USD/JPY. For this currency pair, the base currency is the US dollar and the counter currency is the Japanese yen. The exchange rate provides the price of the base currency relative to the counter currency; i.e., how much is one US dollar (base currency) worth in Japanese yen (counter currency). So if the currency quote for USD/JPY was 118.54 / 57, this would mean that if a currency trader was buying, he would pay 118.57 Yen for 1 dollar and he would receive 118.54 yen for each dollar when selling. When the exchange rate rises, it means the base currency is getting stronger against the counter currency. When the exchange rate falls, the opposite is true. For more information on currency quotes, read "How to read a currency quote."

4. "PIPS"

"Pip" stands for "price interest point" in the currency market, and it represents the smallest fluctuation in price for a given currency pair. For most currencies the exchange rate is carried out to the fourth decimal place. In this case, a pip is 1/10,000th of the counter currency or 0.0001. Fore example if the Ask price in the EUR/USD is 1.1315 and it goes up 1 pip, the resulting rate will be 1.1316. Some exchange rates, like the dollar - yen, are only carried out to two decimal points. Fore these currency pairs, a pip is worth 1/100th of the counter currency. For more information on pip values, read "Calculating profit and loss in currency trading."

5. Currency Cross Rates

Despite the wide international interest in the US dollar and the pricing of local currencies in terms of US dollars, there is also a demand for pricing foreign currencies in terms of other (non-dollar) currencies. These non-dollar-denominated exchange rates are called currency cross rates or simply, currency crosses.

The most popular currency cross rates are euro/Japanese yen (EUR/JPY), euro/British pound (EUR/GBP), and euro/Swiss franc (EUR/CHF). These rates are also called "euro cross rates" since they involve the euro. Some popular cross rates involve neither the euro nor the US dollar. Examples of these cross rates are British pound/Japanese yen (GBP/JPY) and Swiss franc/Japanese yen (CHF/JPY). There are hundreds of cross rates involving other currencies, but the liquidity of the corresponding currency pairs is often low.

One of the advantages of currency trading over stock trading is simplicity. A currency day trader or swing trader could concentrate on a few extremely liquid currencies rather than worrying about thousands of stocks to choose from. For that reason, a beginning trader should exploit this advantage and concentrate on one or a few of the major currencies without worrying about the currency cross rates.

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