Americans drive cars made in Germany, use DVD players made in Japan and wear clothing
made in Italy. The Belgians watch American movies, the Canadians eat Chinese food,
and the Australians watch television on a TV made in the Netherlands.
The world economy is more tightly integrated than ever before, making the foreign
exchange market a place where traders can always find trends to trade.
But, to begin your understanding on how the forex market actually works you must
have a firm grasp of fundamental terminology.
The first two key terms are pairs and pips!
Currency Pairs
Currencies are traded in pairs. In the forex market, a currency exchange rate is
always quoted for a currency pair using the International Standards Organization
(ISO) code abbreviation.
For example, USD/CHF refers to the two currencies in this pair: the U.S. dollar and
the Swiss franc. All trades involve the buying of one currency and the selling of
another.
Therefore, an exchange rate is merely the ratio of one currency valued against another.
The currency in the first position is referred to as the base currency with the
second currency known as the counter currency, displayed in Table 1-1.
| Currency Pair | Base | Counter | Trading Terminology |
| EUR/USD | Euro | U.S. dollar | Euro |
| AUD/USD | Australian dollar | U.S. dollar | Aussie Dollar |
| USD/CAD | U.S. dollar | Canadian dollar | Dollar Canada |
| USD/JPY | U.S. dollar | Japanese Yen | Dollar Yen |
| GBP/USD | British Pound | U.S. dollar | Cable or Sterling |
| USD/CHF | U.S. dollar | Swiss Franc | Dollar Swiss |
| EUR/GBP | Euro | British Pound | Euro Sterling |
| EUR/JPY | Euro | Japanese Yen | Euro Yen |
| EUR/CHF | Euro | Swiss Franc | Euro Swiss |
| GBP/JPY | British Pound | Japanese Yen | Sterling Yen |
A common mistake of traders new to currencies is misinterpreting the chart when analyzing
the direction of a currency trend. A key point to remember is that the chart is drawn in
terms of the base currency.
This is known as an American quote where the U.S. dollar holds the counter position.
Currency pairs that are traded as American quote are the euro, the British pound and
Australian dollar, for example. Some other pairs are traded with the U.S. dollar in the
base position. This represents the reverse position of the American quote.
This position is known as the European quote. Examples of currency pairs that trade in
the European quote system with the U.S. Dollar are the Canadian Dollar, Japanese Yen and
Swiss Franc.
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Currencies that do not contain the U.S. dollar as either the base or counter currency is know as a cross currency pairs. An example of a cross currency pair is EUR/JPY. Traders need to keep in mind the fundamentals of the economies of the two currencies being traded.
In the aforementioned example, Japan and Europe are major global economies; however,
they are not major trading partners. Despite their trade status, these cross-pairs are
heavily traded currencies.
The new global economy is fueling the popularity of trading cross-pairs, especially
giving the ever growing impact of emerging economies in Eastern Europe, South America
and Southeast Asia.
Table 1-2 illustrates a few major currencies and their abbreviations.
| Currency | Abbreviation |
| Australian Dollar | AUD |
| British Pound | GBP |
| Canadian Dollar | CAD |
| Euro | EUR |
| Japanese Yen | JPY |
| New Zealand Dollar | NZD |
| Norwegian Krone | NOK |
| Swiss Franc | CHF |
| U.S. Dollar | USD |
The Pips
A pip (price interest point) is the smallest increment a currency pair price moves. Each
currency pair has its own pip value. The pip is expressed in hundredths of a cent in USD
terms and holds the forth position to the right of the decimal point of the quoted
currency.
The goal of any trader is to capture as many pips as possible, because this simply
determines the profit or loss in any currency trade. Some pip values are fixed while
others fluctuate. The current price of a currency pair is called the spot rate.
Table 1-3 highlights where these pip values are contained in a currency pair.
| Currency Pair | Exchange Rate | Description |
| EUR/USD | 1.2505 | Number of USD to buy one EUR |
| GBP/USD | 1.7505 | Number of USD to buy one GBP |
| USD/JPY | 1.1805 | Number of JPY to buy one USD |
| USD/CAD | 1.2105 | Number of CAD to buy one USD |
The pip value is always based on the counter, whether it is the U.S. dollar or not. In
our example above the U.S. dollar is the counter and is based on a pip value of $10 on
a $100,000 lot trade.
Most FX broker sites have pip calculators available to calculate pip rates when the U.S.
dollar is not the counter currency in the pair.
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It's All About Liquidity
In the forex market, there are a number of currency pairs to be traded. It is also worth mentioning that in the forex market, like any other financial market, it is better to specialize in just a few currency pairs.
This will give the trader an higher chance for success.
In addition to focusing on onlly a handful of currency pairs, traders should take into account the liquidity. this principal can be seen in the best stock market traders and analysist.
They tend to focus on a small basket of stocks that are very liquid versus trying to be the jack of all traders.
The table below details the most attractive currency pairs to trade in terms of liquidity and volatility. Another key determination on deciding which currency pair to trade is the location of the trader.
All traders beginning in forex should first focus on their home currency. Living in a particular country will provide an early edge in understanding the factors that influence the currency pair.
Also, keep in mind which markets are open at which times.
Table 1-4
Most Liquid Currency Pairs
EUR/USD
USD/JPY
GBP/USD
USD/CHF
AUD/USD
Forex Market Timings
We now know that the forex markt is open 24 hours a day and 6 days per week. Since there are major banking systems in almost every time zone, foreign currency transactions are conducted around the clock.
Forex trading literally follows the sun.
Most banking centers deals most heavily in their host countries currency. When Tokyo is open the Yen is the heaviest traded currencies.
Some of the major banking center overlap. European Banks and North American banks are at the same time for a few hours Monday to Friday.
This results in heavy trading volumes between the U.S. dollar and the Europan currencies.
So even though one can trade forex around the clock there are peak periods that usually dictate daily volume and volatility.
Trading begins Monday morning in New Zealand which corresponds to 3:00 PM Eastern Time.
It then moves around the globe through the various financial centers and closes late Friday afternoon after the North American banks end operations for the weekend.
Then the cycle starts again.
| Australia, New Zealand Opens | 19:00 EST (00:00 GMT) |
| Japan Opens |
20:00 EST (01:00 GMT) |
| Europe Opens | 02:00 EST (07:00 GMT) |
| Great Britain Opens | 03:00 EST (08:00 MT) |
| Japan Closes | 03:00 EST (08:00 GMT) |
| Hong Kong Closes | 04:00 EST (09:00 GMT) |
| N.America/NY Opens | 08:00 EST (13:00 GMT) |
| Europe Closes | 10:00 EST (15:00 GMT) |
| Great Britain Closes | 11:00 EST (16:00 GMT) |
| N.America/NY Closes | 16:00 EST (21:00 GMT) |
| West Coast of N. America closes | 18:00 EST (23:00 GMT) |
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