Forex: The IMF has set rules for how currency pairs work in Forex trading. These are the pairs that are traded most often:
- EUR/USD, the euro, and the dollar
- USD/JPY, the Japanese yen and the U.S. dollar
- GBP/USD stands for the British pound and the U.S. dollar (sometimes called "the cable")
- USD/CHF, the Swiss franc and the U.S. dollar (sometimes called "the Swissie")
- USD/CAD, the US dollar and the CAD
AUD/USD is the symbol for the Australian dollar and the U.S. dollar.
On the Forex market, 80% of all trades happen between these pairs. All of them involve the U.S. dollar because the U.S. economy is still the biggest and one of the easiest to trade with. But this is also a holdover from the Bretton Woods Agreement of 1944, which set the U.S. dollar as the standard for all other currencies. Even though the Accord was dropped at the beginning of the 1970s, some of its effects can still be seen in the market.
The first currency in a pair is called the "base currency," and it's the one that matters most. Its value in the exchange rate is always one, and it controls the trade direction and the chart. The cross is the second form of money.
For example, in the GBP/USD, the base currency is the British pound and the cross currency is the U.S. dollar. If the price of this pair is 1.7609, it means that one pound is worth 1.7609 U.S. dollars. If the chart goes up, it means that the pound is getting stronger against the dollar. If the chart goes down, it means that the dollar is getting stronger against the pound.
Because a purchase always involves two currencies, one of which is being traded against the other, you can make money in both a bull market and a bear market. For the same reason, there is no rule against selling short in Forex trading like there is in the stock market. It's built into the system.
The smallest number in the price is called a "pip," which is an acronym for "Price Interest Point." This is an important point because not all pips are the same; they are based on the pair's base currency. If the U.S. dollar is the base currency, then one pip is equal to one dollar in a mini account or ten dollars in a standard account. If you trade one of these currencies and make fifty pips, that's $50 in a mini account and $500 in a standard account.
But if the base currency is something other than the U.S. dollar, then one pip is worth one unit of the base currency. Because the pound sterling is the base currency in the GBP/USD pair, one pip is equal to one pound. In the AUD/USD pair, on the other hand, one pip is equal to one Australian dollar. So, when you take profits in these currencies, you do so in the base currency, which you then have to exchange at the current exchange rate into U.S. dollars.
If the exchange rate is one or more, this is good for U.S. traders. If it's less than one, though, it's not so great. For example, in the GBP/USD, a gain of 50 pips is worth GBP50, not $50 USD. If the exchange rate was still 1.7609, the profit would be about $88.
But a gain of 50 pips in the AUD/USD is worth AU $50, and the exchange rate is more likely to be around 0.7467. So the profit would probably be around US$37.
