FX 101—Financial Literacy
Introducing Foreign Exchange
You’ll often hear people in the business refer to foreign exchange as “forex,” or “FX” for short. Another way to describe it is the currency market. No matter what you call it, the foreign exchange market is essentially a network of people trading certain currencies for other currencies at agreed-upon prices.
The foreign exchange market is the largest, most liquid financial market in the world, trading in one typical day what Wall Street trades in a month. According to a recent estimate, the average daily turnover in global foreign exchange markets is over 5 trillion.
The US dollar is the world’s most traded currency, followed by the euro and the Japanese yen. The most important trading centres worldwide are London, New York, Hong Kong, Tokyo and Singapore. These centres serve as anchors between buyers and sellers around the clock. The FX market operates 24 hours a day, 5.5 days a week.
Good to know
Operating hours. Forex trading runs 24 hours a day, 5.5 days a week. Trading runs from 22:00 GMT on Sunday (Sydney) until 22:00 GMT Friday (New York).
Commissions and service fees. Virtually all companies specializing in foreign exchanges services make their money based on spreads. Most foreign exchange traders also receive commissions (which can also be known as service fees) as incentives on every trade you book. In contrast, Vancity Community Investment Bank Account Managers are not commission-based—so their advice is always objective and tailored to your unique circumstances.
Buying and selling currencies
Many of the same principles that apply to other investments apply to foreign exchange too—for example:
- You’re aiming to buy low and sell high.
- Prices can be volatile—that is, they can move up or down without warning.
- The markets move up and down based on demand. Rising demand leads to rising prices.
Aside from higher interest rates, other factors that can drive demand for a given currency include better return on savings, political stability, and economic output (GDP).
See Reading FX exchange rates for more about what you need to know to buy and sell currencies.
Benefits of the FX market for small businesses
Today, many businesses—even those you might not think of as international—need to buy or sell goods or services to or from other countries. Your own business might be one of them. Doing business across borders means dealing in other country’s currencies, and exposes you to fluctuations in the values of those currencies.
The foreign exchange market makes it possible for a business in one country to import goods from other countries and pay in local currencies. For example, a local supplier of high-end cosmetics may need to import its products from a European country. The foreign exchange market lets that business pay for its imported products in euros, even though its own revenues are in Canadian dollars.
Vancity Community Investment Bank Foreign Exchange can save you money by eliminating the need for your suppliers to mark up their prices to account for the foreign exchange difference between the Canadian dollar and the euro. By trading in the supplier’s currency, you can get a favourable price in real time, or lock in a rate in advance that works for you.
Getting a handle on the terminology
The FX market is associated with a number of words and terms that might be unfamiliar to people who don’t work in the investment or foreign currency worlds. Here are a few technical terms worth knowing:
Spot rate. The “spot rate” refers to the price quoted for settlement on a currency—in other words, it’s the value of the currency at the moment of the quote. It’s based on current and anticipated market value, and can change frequently (and sometimes significantly).
Spreads. A forex “spread” refers to the difference between the bid price and the ask price on a currency pair. The bid is the price the forex market would pay to buy the base currency in exchange for a counter currency. The ask is the price at which the market would sell it. For example, suppose you have a USD/CAD bid price of 1.1500 and an ask of 1.1505. (The first currency mentioned in a pair is the base currency—in this case, the USD.) The spread would be equal to $0.0005. To make money in currency trading, as in other investments, you aim to buy low and sell high.
In the example above, the spread is 0.0005, or 5 pips. Unlike the USD/CAD currency pair, some currency pair quotes are carried out to the second decimal place. For example, USD/JPY may be quoted at 119.45/50, where 5 pips represent a spread of 0.05.
Pips. In foreign exchange terminology, a pip refers to the smallest amount by which a currency quote can change. This is usually $0.0001 for currency pairs involving the US dollar, and may be more often referred to as 1/100th of 1%. A change in the the EUR/USD exchange rate from 1.4550 to 1.4555 would be a 5-pip change.