The Basics of Foreign Exchange

No man is an island. Especially in this global economy, foreign exchange affects everyone in more ways than one.

Foreign exchange, oftentimes referred to as FOREX or FX, is the trading of one currency into another.

As consumers, this is most evident when we travel to another country. We go to a bank or a money dealer to change one currency, usually referred to as "home currency" into the currency of the country we are going to so we are able to pay for goods and services in that country. When we order books or gadgets online, we pay by credit card using a foreign currency. When we receive the credit card bill, the amount has been converted to a local currency.

Conducting business with companies outside your country also results in foreign exchange. The goods you wish to purchase or inversely, the goods you are supplying may be priced in foreign currency and there would be a need to convert to a local currency. In this scenario, as the rates vary, timing would be crucial and can have a significant effect on the business's bottom line.

The currency exchange market determines the exchange rates. Rates are quoted in pairs using a base currency and a quote currency. As an example, USD/PHP would refer to the how many Philippine Pesos you would need to purchase one United States Dollar or conversely, how many Philippine Pesos you would get when you sell one US Dollar. The USD is considered the base currency and PHP is the quote currency.

Exchange rates quoted could be either be a bid price or an ask price. Bid price applies when selling a currency while the ask price applies when buying a currency. The bid price is always lower than the ask price. The difference between the two prices is called the spread.

The currency exchange market is the world's largest market. Its trading volume surpasses that of the bond or even stock market. With dealers in different time zones, it is also a 24 hour market. The bulk of transactions involve the following currencies: the US Dollar (USD), Japanese Yen (JPY), Euro (EUR), Swiss Frank (CHF), British Pound (GBP), Canadian Dollar (CAD), and Australian Dollar (AUD). In most markets, trading is usually against the US Dollar. In these cases, the currency is first traded against the US Dollar before it is converted into the second currency. Thus, trading between two non US Dollar currencies makes the spread higher.