The Types of Forex Trading

Most Forex traders concentrate on six major currency pairs –

  • The euro versus the US dollar (EUR/USD) accounts for 27% of the market
  • the US dollar versus the Japanese yen (USD/JPY) makes up 13% of the market
  • the British pound versus the US dollar (GBP/USD) is 12% of the market
  • next is the US dollar versus the Swiss franc (USD/CHF)
  • then the Australian dollar versus the US dollar (AUD/USD)
  • and the US dollar versus the Canadian dollar (USD/CAD)

The euro versus the Japanese yen is also popular (EUR/JPY), and this is called a cross rate because it’s a currency pair that does not include the US dollar. The dollar as you can see is a dominant factor in the world currency markets, due to the special status it has been granted in global currency affairs as the world’s reserve currency. If you’re trying to avoid US dollar trades during periods when the US dollar is hard to predict, the other common cross rates include the British pound versus the Japanese yen (GBP/JPY), the euro versus the Swiss franc (EUR/CHF), the Australian dollar versus the Japanese yen (AUD/JPY), and the euro versus the British pound (EUR/GBP).

Forex Trading and Leverage

It’s most important to observe the order of the currencies in each pair — for most the US dollar is quoted first, but not all. The first currency mentioned is the base, and the number quoted is how many units of the second currency are needed to buy one of the first. So if you see that the EUR/USD is rising, that means the euro is getting stronger, and it costs more US dollars to buy a euro. On the other hand, if the USD/CAD is increasing, the Canadian dollar is actually losing value relative to the US dollar, as it costs more Canadian dollars to buy one US dollar.

Forex deals in ‘lots’, which traditionally are 100,000 units of currency. This means that, without leverage, you’d typically have to put up $100,000 for each lot you bought or sold. But using the usual leverage of 100 to 1, you’d only have to find $1000 in margin to make the trade. Because of this enormous leverage, your profit potential is greatly multiplied, but, as with all leveraged products, so is your loss potential, and you have to be careful to position size and cut your losses where necessary.

A few traders prefer to deal in the ‘exotic’ currencies, and feel that this small section of the Forex market is easy to predict and has greater potential for gains. The hot exotics include emerging-market currencies, as well as some other lesser known ones. A partial list includes the Turkish lira, Polish zloty, Mexican peso, Thai baht, Hong Kong dollar, Icelandic krona, Hungarian forint, South African rand, and Czech koruna.

The chief differences when trading exotics are that they tend to move much more quickly than the major currencies, which gives you the increased potential for profit, and they usually trend better than the majors. However, exotics can also collapse a lot faster as emerging markets have less stable financial systems. They are also more prone to having economic or political crises. Advocates also say that exotics are more easy to predict from basic factors as they are only influenced by three or four fundamentals whereas the major currencies have a complex set of influences.

If you are interested in intraday trading, you should know that you’re up against the best, as this is a big market for banks and financial institutions. And of course, apart from the spread, which is where the brokers make their profit, Forex trading is a zero-sum game. It’s not even like the equity market, where you can expect shares to increase their value over time if the company is doing the right things. It’s purely a paper exercise, with winners and losers. You do have one advantage over the banks — banks have to close their books each day, whereas you can decide to leave your positions open.

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