Forex 101 Make Money with Currency Trading

How are FOREX currency exchange rates and prices determined? On the foreign currency exchange markets, currencies are always traded in pairs relative to each other. For example the US Dollar (symbol USD) and Japanese Yen (symbol JPY) trade as a pair called the USD/JPY. Forex transactions are quoted in pairs because you are buying one
currency while selling another. The price of the USD/JPY shows how many of the second currency (JPY or Japanese Yen) can be bought with one unit of the first currency (e.g. one US Dollar). So if the USD/JPY is quoted as bid 119.85, ask 119.89 it means you can buy 119.89 yen for one dollar or sell 1 dollar for 119.85.

The price level for any currency pair is not set by mutual agreement between countries. This is completely incorrect. Price levels are determined strictly strictly by supply and demand for one currency relative to another in the huge international interbank market. This is a market for huge international institutions and corporations to convert currencies from one form to another. For example an American company selling goods in Japan may eventually want to convert the Japanese Yen that they earned into dollars so that they can pay their American stockholders dividends in dollars or to invest in a new plant in the US. Financial institutions trading currencies on interbank may also speculate on the direction that currency prices will move based on political news or world economic news. The more that these institutions want to convert other currencies to dollars, the stronger the dollar will get, and its price relative to another currency will rise due to the demand. The dollar will fall when the demand for dollars shrinks relative to other currencies.

On the interbank system the spread between the bid and ask is quite a bit lower than the spread that the retail investor will see. Retail investors (ordinary people), cannot trade currencies on interbank. They typically trade currencies online (on the internet) in the Off Exchange Currency Market. These are not traditional markets because there is no exchange. When you sign up to trade FOREX you are actually trading with a dealer. That dealer can set their own bid / ask spread wherever they want. So if the interbank spread is only 2 pips (e.g USD/JPY 119.86/119.88), the dealer might show a spread of 119.84 / 119.90. The dealer makes money by selling the retail investor at 119.90 and buying from the investor at 119.84. The bigger the spread, the more profit the dealer makes, and the harder it is for the investor to make money. Shop around and compare spread rates and commissions when looking to trade FOREX. Remember you are not actually trading with the whole world you’re trading with a dealer. There are no regulatory rules about how much a dealer can charge.