The foreign exchange market is exploding! About two trillion dollars are being traded
daily! and yet Americans are lagging far behind their international counterparts in entering
this market. How can this be? Americans have never taken the backseat to anyone in any
financial market. Why is forex the exception?
Having lived my first 20 years in Greece and my last thirty in America, I believe I can
offer an educated guess. The American dollar has been the super colossus of currency.
Americans never had to think in terms of their currency's equivalence to any other
currency. This kind of "dollar isolationism" has made the American mind
resistant to thinking in currency pairs, which is the heart of the forex market. How do we
overcome this apparent handicap? education!
I am going to try to introduce the forex market concepts through a real life example.
In 1955 My father and my uncle received $ 100 each from their aunt in Chicago. At the
time one dollar was worth 15 Greek drachmas. My father decided that his 100 USDs
were not doing him any good in Greece so he exchanged them and got his 1500 DRMs.
My uncle kept the 100USDs unchanged for a while. Then, one fine morning, Greece woke
up to the news that the government had devalued the drachma. Instead of one USD being
worth 15 DRMs, it was now worth 30 !. My uncle was ecstatic. His dollars had doubled in
value. Instead of 1500 DRMs he could now get 3000 with his 100 USDs. My father was
inconsolable. He had sold his 100 dollars and now had 1500 drachmas in the bank instead
of 3,000 DRMs worth of USDs.
This is the kind of exchange that make up the forex market. But you do need to learn the
forex lingo in order to communicate and understand the forex world. Now let us apply
forex lingo to our illustration above. In this lingo, my father did not sell his 100 dollars to
buy 1500 drachmas. What he did was: "he sold the USD / DRM currency pair".
When you "sell a pair" it means that you exchange the first member of the pair
for the second. When you "buy a pair" it means that you exchange the second
member of the pair for the first member of the pair. When you buy the pair
USD / DRM You give up your drachmas and hold dollars. That is what my uncle did.
When you sell the USD / DRM pair you give up your dollars and hold drachmas, that is
what my father did. The key to these transactions is to be positioned on the side of the
member of the pair that will appreciate against the other member.
In order to illustrate and further practice the forex lingo of buying and selling a
pair, lets apply it to buying a car. In forex lingo you cannot say that you bought
a car for $ 10,000. In forex you first define the pair, in this case it would be
dollars / car or USD / CAR. If you say that you bought the USD / CAR pair it would
mean that you exchanged the second part of the pair for the first. You gave up
the car in order to get the dollars. That is what the car dealer did. If you say
that you sold the USD / CAR pair it would mean that you exchanged the first part
of the pair for the second. That is what YOU did, you exchanged the first part
of the pair "dollars", in order to get the second, "car". Moral of the story? Don't get hung
up on the terms buy and sell, look at the order of the pairs.
Another way to express the same thing in forex lingo is actually easier to grasp.
You can say that when you bought the car, you went long on the CAR and short
on the USD. The dealer went long on the USD and short on the CAR. Going long on one
member of a pair means that you chose to position yourself as holding that member.
Conversely, going short on a member of a pair means that you positioned yourself with
the opposite member.
If you like this kind of "from the ground up" approach to explaining forex markets,
please stay tuned to this site. In the next article I submit, I will discuss some of the
advantages of trading in forex and also some concepts like "pip" and "carry".