Foreign Exchange is the buying or selling of one currency for another. Commonly referred to as Forex or Fx, it is the most heavily traded market in the world. The equivalent of $6.6 trillion US dollars is traded every day!
Check out our blog: Top 10 Most Traded Currencies 2020
It’s important to have an understanding of FX rates and how they work. Why? So you know enough to recognize when banks and other financial institutions charge you unnecessarily high rates (and they do…often.)
Don’t worry, we’re going to break down the basics of Foreign Exchange for you. Let’s go!
What Determines a Currency’s Exchange Rate?
Foreign exchange rates provide a window into a country’s economic stability. Rates fluctuate daily and are heavily influenced by the following factors:
Inflation: Inflation is the general increase in prices with the fall in the purchasing value of money. A country with a lower inflation rate than another’s will see an appreciation in the value of its currency. A country with higher inflation typically sees depreciation in its currency.
Balance of Payments: This is the difference in total value between payments into and out of a country. Put simply: Payments for exports – Payments for imports = Net balance of payments
If a country has a foreign exchange deficit due to spending more currency on imports, it causes depreciation of its currency as it tends to need more foreign currency than it has earned.
Terms of Trade: This relates to the balance of payments. Terms of trade is the ratio of export prices to import prices. A country’s terms of trade improve if its export prices rise at a greater rate than its import prices. This results in higher revenue, and a higher demand for the country’s currency, thus increasing the currency’s value.
Government Debt: Government debt is national debt owed by a country’s central government. These debts can be owed to other countries or to organisations like the International Monetary Fund (IMF). Countries with high government debt are less likely to attract foreign capital, which paves the way for inflation and currency depreciation.
Interest Rates: Foreign exchange rates, interest rates and inflation are all related. Increasing interest rates cause a country’s currency to appreciate – higher interest rates provide higher rates to lenders. This attracts more foreign capital and causes an appreciation in the recipient country’s currency .
Political Stability: A country’s political climate can have a huge affect on its currency. A country that has no political turmoil is more attractive to overseas investors. The more investors a country attracts, the more its foreign capital increases. This leads to an appreciation in the value of the country’s currency.
Recession: If a country is in recession, its currency weakens. Recessions can cause interest rates to fall, and decrease a country’s chance to acquire foreign capital. As a result, the currency falters and its exchange rate weakens. While this goes contrary to currency changes due to rising interest rates, extremes on either side can lead to exchange rates weakening.
Speculation/Buyers: When a country’s currency value is expected to rise, investors will demand more of it. Their plans to make a profit in the future will increase the demand for the currency. As a result, the currency’s value will rise – with this increase in value comes a rise in the exchange rate as well.
The global pandemic has seen many investors become incredibly risk-averse. As a result, some currency values have dipped, but the 10 strongest remain strong, as they are the safest bet.
Check out our blog: Top 10 Strongest Currencies 2020
Where Can I Get the Best Foreign Exchange Rates?
Most banks and online providers won’t give you the live FX rate when converting money. Almost all banks and financial institutions will markup the price so that they can profit.
While this is not unreasonable, some banks markup much more than others – especially when it comes to currencies that are not heavily traded. The rates you see on boards in banks/exchange bureaus are never that day’s true Forex market ones. They are always higher, because additional variable fees the bank is charging are included.
However, some online Money Service Businesses (MSBs), like us here at Remitr (humble brag) offer the live FX rate for conversions.
Check out our blog: How Foreign Exchange Rates Affect Your Business
How Does Foreign Exchange Operate?
The exchange market is responsible for determining the exchange rate or value of the currencies being traded. In the Forex market, currencies always trade in pairs. Put simply, this means that every transaction exchanges one currency for another. So, if the USD/CAD exchange rate is 1.30, it costs you 1.30 Canadian dollars to buy 1 US dollar.
Currencies are also traded in lots. A micro lot includes 1000 worth of a specific currency, a mini lot includes 10,000, and a standard lot includes 100,000. In online forex trading, you can trade as many blocks as you see fit, whether it’s two micro lots or 50 standard lots.
Going to a bank or bureau de change and exchanging $3000 to euro for your trip to Europe is also Forex trading. This is the foreign exchange expereince most people are familiar with.
A Quick Overview of Forex Trading
When it comes to trading, the first term you should become familiar with is ‘pip’. This stands for point in percentage. A pip is the name used to indicate the fourth decimal place in a currency pair (or the second when Japanese yen is in the pair).
Many currency pairs will move about 50 to 100 pips per day. For example, when the price of the EUR/USD moves from 1.3650 to 1.3700, that’s a 50 pip move. This means that if you bought the pair at 1.3650 and sold it at 1.3700, you made a 50-pip profit.
The profit you would make on the above trade would, of course, depend on how much of the currency you purchased. Say you bought 1,000 units (a micro lot) in USD, then each pip is worth $0.10. This means you would calculate your profit by multiplying 50 pips x $0.10…so you’ve made $5.
|
Micro ($0.10) |
Mini ($1.00) |
Standard ($10.00) |
|
| Purchase @ |
1.3650 |
1.3650 |
1.3650 |
| Sold @ |
1.3700 |
1.3700 |
1.3700 |
| Profit |
$5 |
$50 |
$500 |
Keep an Eye on These: Most Improved Currencies 2019
Probably the best way to learn about forex trading is to place some mock trades with a paper trading account. This way you get to learn without the risk of losing money! Several brokerages offer online paper trading accounts that work exactly the same as live trading accounts, which are ideal for honing your Forex trading skills.
Check out our History of Currency Series:
The History of Currency in Canada
The History of Currency in the USA
The History of Currency in Germany
The History of Currency in Ireland
With REMITR, you never have to worry about currency conversion and poor FX rates.
With us, you can send payments effortlessly, on time, wherever you do business.
