Currencies of advanced economies are exchanged for each other based on prices that constantly fluctuate. Currencies are traded in pairs and form the world’s largest financial market by far, with trillions of dollars exchanged daily. The currency market is commonly called forex, short for foreign exchange.
Currency is any generally accepted form of money, including coins and paper notes, which is issued by a government and circulated within an economy. In the past, objects like cowrie shells were used as currency, and recently, digital virtual currencies like Bitcoin have emerged which are not backed by any national government.
Used as a medium of exchange for goods and services, currency is the basis for trade. Most countries have their own currency. Switzerland’s official currency is the Swiss franc; Japan’s is the yen. The euro is the currency for all the member states of the European Union. In some countries, a foreign currency such as the US dollar is accepted as legal tender.
An exchange rate is the rate at which one currency can be exchanged for another in the global foreign exchange market. The value of a currency is continuously compared to that of other currencies based on numerous factors reflecting the relative strength of each country’s economy. The first currency of a currency pair is called the “base currency”, and the second currency is called the “quote currency.” The currency pair’s value shows how much of the quote currency is needed to purchase one unit of the base currency.
All forex trades involve the simultaneous buying of one currency and selling of another, but the currency pair itself can be thought of as a single unit, an instrument that is bought or sold. If you buy a currency pair, you buy the base currency and sell the quote currency. The bid (buy price) represents how much of the quote currency is needed for you to get one unit of the base currency. Conversely, when you sell the currency pair, you sell the base currency and receive the quote currency. The ask (sell price) for the currency pair represents how much you will get in the quote currency for selling one unit of base currency.
The most heavily traded forex pairs are: EUR/USD, USD/JPY, GBP/USD, and USD/CHF. These pairs are considered by many to drive the global forex market. Some add the USD/CAD and AUD/USD pairs to the list of major forex pairs.
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