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Foreign Currency Exchange and Forex Trading, explained

We live in an increasingly globalised world, and most of us have exchanged one currency for another at some point in our lives. Most commonly this occurs if you go on holiday or move abroad, and you exchange the currency of your home country for the currency of the country you’re visiting. This process may then be repeated in reverse if you’re lucky enough to return home with some leftover foreign currency.

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Depending on the exchange rates at the time, and how strong one currency is versus the other, you may make or lose a little money each time you carry out such an exchange. In this way, we are all ‘forex traders’ in our own right – particularly if we travel a lot or are an expat living abroad.

But there’s also a substantial difference between exchanging currencies for everyday purposes, and carrying out actual forex trading, in which much larger sums of money are generally exchanged speculatively in order to profit from exchange rate swings.

Essential Terms Every Expat Should Know

Whether you’re an expat, you’re travelling or you’re planning on trading currencies for profit, there are a few essential terms you need to know:

Currency pair – Forex trading and foreign currency exchange operates in pairs of currencies in which you trade one for another, for example pounds sterling and US dollars. This example would appear as GBP/USD, with the first currency being the ‘base currency’ and the second the ‘quote currency’

Bid price – The price at which a broker will buy a unit of currency from you

Ask price – The price at which you can buy a unit of currency

Spot rate – The ‘interbank’ rate at which banks and other financial institutions are currently trading currency pairs

Spread – The difference between the bid price and ask price

Commission – The fee charged by the broker or other provider for exchanging currencies

What is foreign currency exchange?

Foreign currency exchange is the term generally used to describe the act of exchanging one currency to another for the purposes of travel – i.e. in which you are exchanging a lump sum that you will use in the real world when travelling to a foreign country.

And what about foreign exchange (forex)?

Forex trading refers to buying and selling of currencies based on their price movements, with the intention of making profit rather than acquiring a particular currency for a specific purpose such as actually visiting the country. While the fluctuations in price can be small relatively speaking, when forex trading in large amounts the resulting profits can be substantial.

So, while the two concepts are related, the overall purposes and the elements that need to be considered are quite different. When exchanging currencies for practical purposes, the only things you really need to consider are what currency you need and any factors that might affect the exchange rate at that time. With forex trading, on the other hand, there are many more things to consider, which may affect the decisions you make in choosing which currencies to buy and sell, and when.

There are many fundamental factors that can affect the value of currency, and thus the exchange rates between different currencies, and hence their profitability when forex trading. These include: the interest rates set by central banks, the economic stability of the countries in question, the amount of international trade taking place, the amount of government debt and major global and political events, such as Brexit.

If you’re planning on trying your hand at forex trading, be sure to spend time getting to understand these factors and how they can affect your trades!

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