We’re all familiar with money. It’s a big part of our lives from early childhood right up to our later years. It’s the thing we strive for and the thing that makes our lives possible, but we generally only think of it in the conventional sense – as something we earn then spend within our own country and culture. We seldom consider money on a global scale or how the money from one place is related to money from another.
In fact, the relationship between different currencies of different countries is a vital issue, and one that becomes more and more important as we continue to expand the scope of the world wide commercial markets. Every company that sells its products to another country needs to be concerned with the relationship of their own money and its value to the value of their partner country’s currency. When they sell their products in Japan, say, a British company will be paid in Japanese Yen, but they need to convert those Yen to the local currency (traditionally the Pound, but these days it’s the Euro) so they can use it to pay their workers and purchase more raw goods. If the value of the Euro goes up vs. the Yen a British company will find that the money it receives from its Japanese customers is not as great, and they may need to consider raising their prices. Conversely, if the value of the Pound declines against the Yen, they will enjoy increases in their profits even if they leave their prices unchanged. They may in fact consider cutting their prices to increase their Japanese sales.
Converting the currencies in this way between one country and another is a multi-trillion dollar a day industry, and the fact that prices of currencies are in almost constant state of change creates an opportunity for profit. You can buy and sell currencies on the Foreign Exchange, or Forex market. With Forex, currencies are offered in pairs, for instance to trade the Pound against the Yen as we discussed above, you would trade the Pound/Yen, or GBPJPY as it’s notated.
If you think the value of the pound will rise against the Yen, you would ‘buy the GBPJPY’, which is equivalent to buying British Pounds and paying for them with Japanese Yen. Later you would close your position essentially by selling back the Pounds you bought and accepting Yen in exchange. If you were right, and the Pound rose against the Yen, you would receive more Yen than you originally paid and the difference would be your profit. If, however, you were incorrect and the Pound fell against the Yen, you would have lost money, because you would receive fewer Yen than you originally paid.
That’s the idea in a nutshell. There are a lot of details involved in really understanding the Forex market. I’ll cover other aspects such as brokers, order types and leverage in future posts.
