Forex (also known as FX) is the short form of foreign exchange, which quite simply refers to the conversion of one currency into another. Forex is the largest financial market in the world – and one of the most volatile.
There are many factors that can affect the demand levels of a currency over either a short-, medium- or longer-term timeframe.
|Short-term considerations||Risk appetite, volatility, moves in commodity prices, interest rate pricing and positioning|
|Medium-term considerations||Current account surplus/deficit, fiscal policy, political risk, bond yield spreads (or differentials) and relative economic growth|
|Longer-term considerations||Purchasing power parity, net foreign assets and terms of trade|
Market sentiment can also play a major role in driving currency prices. If traders believe that a currency is headed in a certain direction, they will trade accordingly and may convince others to follow suit, increasing or decreasing demand accordingly.
But demand isn’t the only variable that can impact a currency’s price. Supply is controlled by central banks, who can announce measures that will have a significant effect on their currency’s price. Quantitative easing, for instance, involves injecting more money into an economy, and can as such cause its currency’s price to drop.
Theoretically you can exchange any currency in the world for any other currency, which means the variety of forex pairs you could potentially trade is vast.
In practice, the majority of forex trades take place on a few select currency pairs called the majors. What constitutes a major pair varies widely depending on who you speak to, but most include the following six which account for over 80% of global forex trade:
|Currency pair||Currency names|
|USD/JPY||US dollar/Japanese yen|
|USD/CHF||US dollar/Swiss franc|
|USD/CAD||US dollar/Canadian dollar|
|AUD/USD||Australian dollar/US dollar|
All of these pairs include the US dollar, which is by far the single most traded currency in the world.
Pairs which are traded less frequently are known as minor currency pairs. You may also see them referred to as cross-currency pairs or simply crosses, particularly if the US dollar isn't involved. The most popular minor pairs tend to contain the euro (EUR), sterling (GBP) or the Japanese yen (JPY).
Some forex brokers may also refer to exotic or emerging pairs. These generally consist of one major currency against another from a small or emerging economy, for example GBP/MXN (sterling vs Mexican peso) or USD/PLN (US dollar vs Polish zloty).
You may also come across forex classes which are based on a region, such as Australasian pairs or Scandinavian pairs. These classes set currencies from their respective regions against one another, or pair them with others from around the world. For example AUD/NZD (Australian dollar vs New Zealand dollar) could be categorised as an Australasian pair, while EUR/NOK (euro vs Norwegian krona) would be a Scandinavian pair.