The foreign exchange market is where countries trade their currencies with one another.
This decentralised global market allows for easy conversion of one currency into another, thus creating opportunities to make money using this system.
Foreign exchange market
The foreign exchange market operates under several different rules and regulations set forth by local governments.
The most important of these rules centre around what is known as “decimalization”.
Before decimalization, many national currencies had fractional units that were expressed in halves (1/2), quarters (1/4), eighths (1/8), sixteenths (1/16), etc.
These fractional currencies often resulted in brokers having to do a significant amount of maths when conducting trades that involved anything more than the most basic currency conversions, thus leading to potential broker mistakes.
More importantly, it would lead to people not feeling confident about entering the market due to their inability to quickly and easily calculate risks associated with any given trade.
Once countries started moving away from using fractional units, forex brokers could use simple decimals throughout their platforms.
When traders place an order for 100 GBP/USD (British Pound / U.S. Dollar), they are essentially saying that they want 1 (one) British Pound, in exchange for $1.6025 (or 1602500/100000). As you can see by this example, decimalization made trading forex much simpler.
Since the foreign exchange market is decentralised and operates on an international scale, any currency pair becomes valid.
It means that there are limitless possibilities when it comes to trading currencies with one another (and even more possible combinations of those primary two currencies).
Let’s say, if you want to buy 100 Malaysian Ringgit (MYR) against U.S. Dollars (USD), you place an order for “100 MYR/USD” or “1 USD/MYR.” Since this type of trade involves selling USD and buying MYR, the trade will move the value of USD down relative to MYR (even though your trade is in USD).
Considering the above, you will often encounter traders that stick to trading “major” currency pairs.
This type of thinking is understandable given that these are some of the most heavily traded currency pairs in existence, and they are usually very liquid markets as well.
Still, it does not mean that you can not make money trading “minor” currencies.
When you use your imagination and think about the possibilities, there is no end to the types of currency pairs that you can find in today’s market (even if they are less liquid than significant pairs).
Since most investors prefer to hedge their trades against USD, it means that most minor currencies trade against USD (with some exceptions such as EUR/GBP and GBP/JPY).
It allows traders to make money even though they hold very little of said foreign currencies. It is demonstrated by how someone who holds 100 AUD (Australian Dollar) could buy 100 JPY (Japanese Yen) and sell those for a profit even before obtaining any Japanese Yen at all.
It provided that they can correctly predict which direction the AUD/JPY trade will move.
AUD/JPY, AUD/CHF, EUR/GBP, and GBP/JPY are examples of minor currency pairs in today’s market.
Regulations (bank transactions)
Each bank has its requirements for making international transfers; however, specific standards help dictate how these transactions occur.
The most common way of conducting foreign exchange transfers is by registering with a banking agency to become an Intermediary Between Exchanges – known as an IB.
When you register with one of these agencies, they will assign you a Bank Identification Code (BIC), which is made up of 8 or 11 characters depending on how your particular bank was set up.
After you have your BIC, specific regulations dictate how much money you can transfer and what types of transfers are permitted.
These restrictions vary based on where you live and depend on which forex broker / IB you will be used to fund your account(s). Banks typically place severe limitations when transferring funds to or from countries where they do not hold strong ties.
The most common way of conducting these transfers is through an Electronic Funds Transfer (EFT), which uses the Automated Clearing House (ACH) to move money around.
This system allows you to transfer large sums of money with relatively limited restrictions instead of wiring smaller amounts.