The foreign exchange market is where currencies are swapped for one another. Banks, companies paying foreign suppliers, central banks, funds and, increasingly, individuals all take part. There is no single exchange: prices are formed across a network of dealers, which is why the market runs around the clock from Monday morning in Asia to Friday evening in New York.
Reading a currency pair
Currencies are always quoted in pairs. In EUR/USD 1.0850, the euro is the base currency and the US dollar the quote currency: one euro costs 1.0850 dollars. If the number rises, the euro is strengthening against the dollar; if it falls, the dollar is strengthening.
Pairs are usually grouped into three families:
- Majors - the US dollar against the euro, yen, pound, Swiss franc, Canadian, Australian and New Zealand dollars. They are the most traded and usually the cheapest to deal in.
- Crosses - pairs without the dollar, such as EUR/GBP or AUD/JPY.
- Exotics - a major currency against a smaller one, such as USD/ZAR or EUR/TRY. Costs and price jumps tend to be larger.
Bid, ask and spread
A dealer shows two prices: the bid (what they will pay you) and the ask (what they will charge you). The gap is the spread, and it is a cost you pay the moment you open a position. Spreads widen when markets are thin - late at night, around holidays and in the minutes around major data releases.
Pips and lots
A pip is the standard unit of price change: the fourth decimal place for most pairs (0.0001), the second for pairs quoted in yen (0.01). Position size is often expressed in lots: a standard lot is 100,000 units of the base currency, a mini lot 10,000, a micro lot 1,000. On a standard lot of EUR/USD, one pip is worth about ten US dollars, so a move of 50 pips is a gain or loss of roughly 500 dollars.
Worked example. EUR/USD moves from 1.0850 to 1.0820. That is a 30-pip fall. On a micro lot (1,000 euros) one pip is worth about 0.10 dollars, so the change in value is about 3 dollars; on a standard lot it is about 300.
What moves exchange rates
Over the long run, exchange rates reflect differences in interest rates, inflation, growth and trade balances. In the short run they react to central-bank decisions, employment and inflation data, political news and shifts in general risk appetite. Even well-informed professionals regularly get short-term direction wrong: the market already prices in what is widely expected, and it moves on what is not.
Where retail traders usually go wrong
- Using too much leverage, so that a normal daily move wipes out a large part of the account. See CFDs and leverage.
- Ignoring costs: spreads, commissions and overnight financing add up quickly for frequent traders.
- Trading around news without understanding that prices can jump past stop-loss levels.
- Following "signals" from strangers on messaging apps. See spotting investment scams.
This guide is general education, not personal advice. Rules differ by country; check your regulator's website for the requirements that apply to you.