How Foreign Exchange Work?

The market determines the value, also known as an exchange rate, of the majority of currencies. Foreign exchange can be as simple as changing one currency for another at a local bank. It can also involve trading currency on the foreign exchange market. For example, a trader is betting a central bank will ease or tighten monetary policy and that one currency will strengthen versus the other.

 

Currency Pairs and its prices:

When trading currencies, they are listed in pairs, such as USD/CAD, EUR/USD, or USD/JPY. These represent the U.S. Dollar (USD) versus the Canadian Dollar (CAD), the Euro (EUR) versus the USD and the USD versus the Japanese Yen (JPY).

 

There will also be a price associated with each pair, such as 1.2569. If this price was associated with the USD/CAD pair it would mean that it will cost 1.2569 CAD to buy one USD. If the price increases to 1.3336, then it now costs 1.3336 CAD to buy one USD. The USD has increased in value (CAD decrease) because it now costs more CAD to buy one USD.

 

In the forex market currencies are traded in lots, called micro, mini, and standard lots. A micro lot is 1000 worth of a given currency, a mini lot is 10,000, and a standard lot is 100,000. This is different than when you go to a bank and want $450 exchanged for your trip. When trading in the electronic forex market, trades take place in set blocks of currency, but you can trade as many blocks as you like. For example, you can trade seven micro lots (7,000) or three mini lots (30,000) or 75 standard lots (750,000), for example.