Money or currency is the ultimate commodity. Every time a company or government buys or sells products and services in a foreign country, they are subject to a foreign currency trade; the exchanging of one currency for another. Many individuals and organizations also trade currencies for speculative purposes. With all of these currency transactions going on daily, it is no wonder that the foreign currency exchange market, also known as "forex" or "fx" market, has such a huge global reach and has become extremely popular among traders.

Trillions of dollars of foreign exchange activity takes place every day. From 1997 to the end of 2000, daily forex trading volume surged from US$5 billion to US$1.5 trillion. The forex market continues to grow at a phenomenal rate.

Before the internet came along, only corporations and wealthy individuals could trade currencies in the forex market through the use of the proprietary trading systems of banks. These systems required as much as US$1 million to open an account. Thanks to advancements in online technology, today investors with only a few thousand dollars can have access to the forex market 24 hours a day.

For traders, forex trading provides an alternative to stock market trading. While there are thousands of stocks to choose from, there are only a few major currencies to trade (the Dollar, Yen, British Pound, Swiss Franc, and the Euro are the most popular). Forex trading also provides a lot more leverage* than stock trading, and the minimum investment to get started is a lot lower. Add to that the ability to choose flexible trading hours (forex trading goes on 24 hours a day) and you have the reason why so many stock traders have flocked to day trade currencies.

All currency trades involve the buying of one currency and the selling of another, simultaneously. Currency quotes are given as exchange rates; that is, the value of one currency relative to another. The relative supply and demand of both currencies will determine the value of the exchange rate.

When a currency trader places a trade he wants the currency purchased to appreciate in value versus the currency sold. His ability to determine the direction that the exchange rate will move, will dictate his gain or loss in a trade. Let's do an example with a currency quote obtained from the forex trading system.

Hypothetical Example of a forex trade

The current bid-ask price for EUR/USD is 1.0120/1.0126, meaning you can buy 1 euro (EUR) for 1.0126 US dollars (USD).

Suppose you feel that the EUR is undervalued against the dollar. To execute this strategy, you would buy Euros (simultaneously selling Dollars) and then wait for the exchange rate to rise.

So you make the trade: purchasing 100,000 EUR (1 lot) and selling 101,260 Dollars. (Remember, at 1% margin, your initial margin deposit would be 1,000 Euros.)

As you expected, EUR/USD rises to 1.0236/42. Since you bought Euros and sold Dollars in your previous trade, you must now sell Euros for Dollars to realize any profit. You can now sell 1 EUR for 1.0236 Dollars. When you sell the 100,000 Euros at the current EUR/USD rate of 1.0236, you will receive 102,360 USD.

Since you originally sold (paid) 101,260 USD, your profit is US $1100 (please note: if the price of the Euro against the US Dollar would have gone down instead of up by the same amount in the example above, there would have been a loss of $1100 instead of a profit. A possibility for profit is always accompanied by a risk of loss).

Total profit = US $1,100.00

Before trading currencies an investor has to understand the basic terminology of the forex market, including how to interpret forex quotes. In every foreign exchange transaction an investor is simultaneously buying one currency and selling another. These two currencies make up a currency pair. This is an example of a foreign currency exchange rate of the dollar versus the yen:

USD/JPY = 119.72

The currency to the left of the slash ("/") is called the base currency (in this example, the US dollar) and the one on the right is called the quote currency or counter currency (in this example, the Japanese Yen). This notation means that 1 unit of the base currency (that is, 1 dollar) is equal to 119.72 Japanese Yen. If buying, the exchange rate specifies how much you have to pay in units of the quote currency to buy one unit of the base currency; in the above example, you have to pay 119.72 yen to buy 1 US dollar. If selling, the foreign currency exchange rate specifies how much units of the quote currency you get for selling one unit of the base currency; in the above example, you will receive 119.72 Japanese Yen when you sell 1 US dollar.

As with stocks, a forex quote includes a bid price (or bid) and an ask price (or ask). This can be easily illustrated with an example of a currency quote taken from the forex trading software:

In the above example, the bid price is 119.68 yen and the ask price is 119.75 yen [notice that when the ask price is displayed, only the last two decimal places are displayed to the right of the slash (75 instead of 119.75)]. The bid price is the price at which dealers are willing to buy the base currency (in units of the quote currency) and users of our software can sell. Thus, if a trader presses the button "Sell USD," he/she would sell dollars at 119.68 yen. The ask price, on the other hand, is the price at which dealers are willing to sell the base currency and users of our system could buy it. By clicking "Buy USD," an investor would be buying dollars at 119.75 yen.

Even though there are many currencies all over the world, 85% of all daily transactions involve trading a group of currencies known as the "Majors." These currencies include the US Dollar, Japanese Yen, Euro, British Pound, Swiss Franc, Canadian Dollar and Australian Dollar. The four most actively traded currency pairs are the US Dollar / Japanese Yen (USD/JPY), Euro / US Dollar (EUR/USD), British Pound / US Dollar (GBP/USD), and the US Dollar / Swiss Franc (USD/CHF). The US Dollar / Canadian Dollar (USD/CAD) and the Australian Dollar / US Dollar (AUD/USD) are also actively traded pairs. For traders, the best trading opportunities are with the most commonly traded (and therefore most liquid) currencies; i.e., the "Majors."

The examples below were taken from the currency dealing system which provides forex real time quotes. From left to right are the euro-dollar exchange rate, the british pound-dollar exchange rate, and the dollar-swiss franc exchange rate. All of these currency quotes are of major currency pairs.

Taking the example of the euro forex quote (first pair above), buying one euro would cost 1.0099 US dollars and selling would provide 1.0093 US dollars.

If you want to see more live currency quote examples, you can sign up for a free test drive of our forex trading software by clicking the appropriate link below. You will be able to obtain live forex quotes as well as place simulated trades in real time using different currency pairs.

If you are interested in online currency trading, you will find the forex market offers several advantages over stock and futures trading. The advantages of forex trading are as follow:

1. 24-hour forex trading
Forex is a true 24-hour market. Whether it's 6 PM or 6 AM, somewhere in the world there are buyers and sellers actively trading foreign currencies. Traders involved in forex trading can always respond to breaking news immediately, and profit and loss is not affected by after hours earning reports, analyst conference calls, nor trading stoppages due to "pending news" or announcements.

After hours trading for U.S. stocks and futures brings with it several limitations. ECN's (Electronic Communication Networks), also called matching systems, exist to bring together buyers and sellers - when possible. However, there is no guarantee that every trade will be executed, nor at a fair market price. Quite frequently, traders must wait until the market opens the following day in order to receive a tighter spread.

2. Superior liquidity
With a daily trading volume that is 50 times larger than the New York Stock Exchange, there are always broker/dealers willing to buy or sell currencies in the forex markets. The liquidity of the forex market, especially that of the major currencies, helps ensure price stability. Traders can almost always open or close a position at a fair market price. This is a huge advantage of forex trading.

Because of the lower trade volume, investors in the stock market and other exchange-traded markets are more vulnerable to liquidity risk, which results in a wider dealing spread or larger price movements in response to any relatively large transaction.

3. 100:1 Leverage in forex trading
100 to 1 leverage is commonly available from online forex dealers, which substantially exceeds the common 2:1 margin offered by equity brokers, and 15:1 in the futures market. At 100:1, traders post $1000 margin for a $100,000 position, or 1%. Increasing leverage increases risk.

While certainly not for everyone, the substantial leverage available from online forex trading firms can multiply both gains and losses. Rather than merely loading up on risk as many people incorrectly assume, leverage is essential in the forex market. This is because the average daily percentage move of a major currency is less than 1%, whereas a stock can easily have a 10% price move on any given day.

The most effective way to manage the risk associated with margined forex trading is to diligently follow a disciplined trading style that consistently utilizes stop and limit orders. Devise and adhere to a forex trading system where your controls kick in when emotion might otherwise take over.

4. Lower transaction costs
It is much more cost-efficient to trade forex in terms of both commissions and transaction fees

Commissions for stock trades in the online discount brokerage world typically range from $7.95-$29.95 per trade, with full service brokers typically charging $100 or more per trade. An average commission on a futures trade is $15 a round turn. Forex brokers offer much lower commission structures. Thus, investors involved in forex trading could limit their cost.

5. Equal profit potential in both rising and falling markets
every open forex position, an investor is long in one currency and short the other. A short position is one in which the trader sells the base currency in anticipation that it will depreciate. This means that, in forex trading, potential exists in a rising as well as a falling market.

The ability to sell currencies without any limitations is another distinct advantage over equity trading. In the US equity markets, it is much more difficult to establish a short position due to the Zero Uptick rule, which prevents investors from shorting a stock unless the immediately preceding trade was equal to or lower than the price of the short sale. This limitation does not exist in forex trading.