When trading currencies you will realize that part of the currency pair quotes always includes a Bid and Ask price very much similar to most financial products available; these are called foreign exchange prices. In every day language the Bid is the figure at which one trader is willing to let go of a currency and the Ask is the term that best describes what we call the offer which in every day language is the price at which a trader is willing is to purchase a currency. In foreign exchange prices you should realize that the Bid will always be the figure that matches the smaller number on the quote.
What in foreign exchange prices we call spread is in reality the difference between the Bid and the Ask price which basically means the difference to what is for sale and what traders are willing to pay for similar products up for sale. In forex you will additionally often see the spread abbreviated as pip spread or simply pip.
If you might be a rookie you might consider forex to look like rocket science where in reality it is simply not; forex does not address a specific target audience and it is not a trading practice that can only be practices by the few which is why it has become so popular and so widespread.
We would recommend you take your forex trading understanding step by step by firstly getting a clear understanding of the basic rules attached to trading which first of all start from the fact that in a currency quote the currency listed first or to the left is always the base currency the currency which is the reference point in regards to the exchange rate of the second. Additionally the currency listed to the left or first will always be 1.
The total number of factors that influence trades operate in a chain with some playing key roles in the overall outcome and some being simply contributing factors of the equation of a possible change. The main factors that influence foreign exchange prices are of course the volume of international trade and investment flow which in turn determine the flow of the supply and demand law with contributing factors being economic and political conditions like war, embargos, diplomatic meetings, leader meetings, international meetings, financial aid packages, inflation, political and economic stability or instability.
These factors might not have a permanent effect on the exchange rates of currencies but they might cause down swings or up swings accordingly to what kind of reaction they blow out to the general public and the investing community. This might seem tricky but in reality is what makes the forex market a spontaneous market as reactions are quick and they change constantly therefore allowing traders to engage in quick and effective trades based on the flow of information and the flow of news around the globe. As the forex market is a 24 hour market it offers a plethora of opportunities around the clock to capitalize on information or predictions which do not require you to await for normal trading hours to be enabled in order to take advantage of breaking news or a possible political condition that might be taking place in a region of the world running 8 hours ahead of your regional timezone and therefore affect foreign exchange prices.
The fundamentals of economics is that if there is an increase in supply the price of the commodity will fall – provided other factors remain unchanged. This theory can be applied to the supply of the currency of a country. If that supply spikes then it requires more of that particular currency to buy the currency of another country. For instance, if there is huge increase in supply of Canadian dollars then it becomes less valuable in relation to currencies of other countries. Thus the rate exchange of the Canadian to the U.S. dollar will fall to 50 cents from 67 cents. Each Canadian currency would give fewer numbers of U.S. dollars than previously. On the other hand U.S. to the Canadian rate of exchange would increase to $2 from $1.49. The foreign exchange market trades in currencies and with time the supply of currency changes. There are some different entities whose activities cause the increase in supply in the foreign-exchange-market.
Let us take the instance of a farm in South Africa selling its produce, cashew nuts, to a mega Japanese company. Most likely the deal will be based on the Japanese currency – the Yen. So the farm will be paid in a currency that is not of much circulation outside Japan. Since the farm has to make payments to its workers in the South African local currency, the rand, the farm will sell its Yen in the foreign exchange market and purchase rands. The supply of the Yen in the foreign exchange market will go up and the supply of rands will go down. This will result in the rand to be appreciated in value (acquire greater value) in relation to various other currencies while Yen will be depreciated.
In another example suppose a manufacturer of automobiles in Germany desires to set up a new plant at Windsor at Canada. For the purpose of purchasing land, hiring construction labourers and other related expenses the German manufacturer will require Canadian Dollars. But the company has mainly euro reserves in cash. Thus it will have to go to the foreign-exchange-market for the purpose of selling some Euros so as to purchase Canadian Dollars. This leads to the euro supply in the foreign-exchange-market to increase and the Canadian Dollar supply to fall. Thus Canadian Dollars will be appreciated while the Euros will be depreciated. It is not only in tangible goods like land that foreign investment is concerned with. If investors in Germany purchase stocks of Canada, like those listed on Toronto Stock Exchange, or buy Dollar bonds of Canada, it will lead to a similar situation.
Similar to the stock-market there are some investors who attempt to build their fortune (and sometimes their living) by purchasing and selling of currencies. For instance an investor dealing with currencies believes that the peso of Mexico will be depreciated in future; its value will become less than that of other currencies than what it is presently. In such a situation the investor will most likely sell off the pesos in the foreign-exchange-market and purchase another currency in its stead – may be the won of South Korea; hence when the supply of pesos increases, that of won decreases. This results in the depreciation of the peso and the appreciation of the won.
The investors entertain such beliefs that will be to their advantage. If the investors think that in future a certain currency will be depreciated they will attempt to sell it quickly there and then. Since it is the investors that are doing the selling, the supply of this currency will increase and its price fall. The investor believed that the currency would be depreciated and acting on that assumption, he or she sold off that currency. This act of selling off causes the depreciation to happen. In economics such self-fulfilling predictions are not uncommon.
The Federal Reserve is the central bank of America – commonly referred to as ‘The Fed’. One of its responsibilities is the controlling of the supply of currency circulating in the market. The simplest manner in which the supply of that currency can be increased is to print more notes. But there other sophisticated methods by which the currency supplies can increase and therefore affect the foreign exchange prices of the currency itself. By printing of bills of $10 and $20 the supply of money will spike. If the government resorts to increasing the supply of currencies it is inevitable that some of it will go into the foreign-exchange-market; this will result in an increase of U.S. Dollars there also.
It often happens that the central bank will directly increase currency supply in the foreign exchange market. The central banks, similar to the Federal Reserve, keep with it a reserve of nearly all the currencies and often make use of them to impact on the rate of exchange. For instance if the Federal Reserve thinks that the Dollar of U.S. has appreciated too much in relation to the forex rates of the Yen, then it will sell off some of its Dollars and purchase Yen. This will push up Dollar supply in the foreign exchange market and cause a decrease in Yen supply. This will result in depreciation of the Dollar value in relation to the Yen. Understandably the Federal Reserve cannot continue to do this will fully as it might result in exhausting of its reserve of currencies. Similarly the Bank of Japan, (the central bank of Japan) may think that the forex trading price of the Yen is being too much manipulated by the Federal Reserve and could counteract this move by selling off Yen and purchasing Dollars.