Forex, or the foreign exchange market, is the largest global financial market, trading more than $5 trillion dollars every day. Unlike the traditional stock market, a forex trader has no governing body regulating trades or arbitration panels to help with any disputes. Trading happens solely online and in pairs, which is different than traditional stock markets.
Currency trades happen in trading pairs, with seven major pairings making up 80% of the market. These pairings are:
So, how do Forex trading pairs work? When a trader chooses a trading pair, they go long on one and short on the other. For example, if a trader decides to sell 500 units of the trading pair USD/JPY, they would be exchanging dollars for Japanese yen. Now they are short on dollars and long on the yen. Another way to look at it is if you bought a $500 TV, you would be short $500 and long one TV. The trader is simply trading one currency for another.
Anyone who has traveled to another country has most likely used a form of forex trading. When you convert your country’s currency to another country’s currency, you exchange its market value. You are going long on (buying) the new currency and short on (selling) your country’s currency. This is how trading pairs work.
The most popular form of trade is called carry. With carry, you determine which trading pair to choose by the interest of each countries currency. A trader determines if a currency has a high interest rate and goes long on it by financing (going short) with a lower interest rate currency.
When the exchange rate or value for one currency increase over the other in a pair you, make a profit. If traders want to sell in a different currency, they can borrow on it, similar to a loan. For example, if you wanted to go long on the Dollar and short on the Japanese Yen, you could borrow the yen and invest long in the USD/JPY pairing.
You will need a broker to invest in the forex market, and it is vital to choose one that is well regulated to avoid scammers. A crucial part of successfully trading currency pairs is knowing how to speculate the market. Unlike the stock market, the forex doesn’t have government regulations, which means insider trading, which would be illegal in a typical market setting, is entirely legal. Frequently banks will leak information on their countries’ currency to help drive the forex market.
Understanding forex trading pairs can seem overwhelming at first, but the forex market isn’t as confusing once you grasp the concept. When you go long on one currency, you are going short on its pairing. If the interest rate on the long goes up, you make a profit. That’s all there is to it!
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