How does the currency market work?

In the foreign exchange market currencies are bought or sold. The goal of Forex trading is exchanging one currency for another with the expectation that the price will fluctuate, so that the currency you bought increases in value compared to the one you sold

What is the exchange rate?

It is the ratio of the value of one currency to another currency. With a example is easier to understand, USD/CHF The exchange rate indicates how many US dollars one Swiss franc can buy, or how many Swiss francs you need to buy one US dollar.

In order to understand currency pairs you have to know that in the foreign exchange market they are always quoted in currency pairs, for example as EUR/USD or USD/CHF. This is so because each foreign exchange transaction that they are at the same time the purchase of one currency and the sale of another.

Let’s see an example of an exchange rate of the Euro against the US Dollar:

EUR / USD where the Exchange Rate is 1.1293:

The currency to the left of the separator (“/”) is the base currency (the euro in this case), while the one on the right is called the quote currency (US dollar in this case). When we make a purchase, the exchange rate will tell us how much we have to pay in units of the quoted currency in order to buy one unit of the base currency.

Following the example, we have to pay 1.1293 US dollars to buy 1 euro. When selling, the exchange rate tells you how many units of the quote currency we get from selling one unit of the base currency, so we will receive 1.1293 US dollars when we sell 1 Euro.

In this way if we buy EUR/USD this simply means that we are going to buy the base currency and at the same time sell the quote or counterpart currency. So, if we think the base currency is going to go up relative to the quote currency, we would buy the pair and sell the pair if we think the base currency is going to go down relative to the quote currency.

If we buy, it means buying the base currency and selling the quote currency, in short, we want the base currency to rise in value and then we sell it at a higher price. Speaking in Trader terms, this is called “going long” or taking a “long position”. When you talk to a Trader remember that if he tells you long is equal to buy.

On the contrary, if we sell it means to sell the base currency and buy the quote currency, that is, we want the base currency to reduce in value and then we would buy it at a lower price. This is called “going short” or taking a “short position”. So short = sell.

Sounds interesting to you, right? Keep learning with DTP with upcoming articles on our Blog.

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