The Exchange Rate: The Core Concept in the Forex

The Exchange Rate: The Core Concept in the Forex

There are many things a new trader in the foreign exchange market must get used to, especially the things that make the forex world tick. Foremost of these vital things to understand and get used to is the concept of the exchange rate which is not surprising since the forex is all about the bartering of one currency for another.

So what exactly is an exchange rate? This question may seem trivial to some who are already seasoned in the business world but for those who are still a little bit wet behind the ears concerning financial matters such as this, it is important that concepts that are fundamental to the forex such as the exchange rate be explained thoroughly.

The exchange rate basically indicates a particular currency's worth relative to the worth of another. The higher a currency's value in another currency, the higher the currency's worth relative to that another currency.

For instance, let's say that the exchange rate for the euro and the US dollar is 1 euro for two dollar or as they say it in the forex, EUR/USD = 2. This means that the value of a euro is equivalent to the value of 2 dollars or you can also say that the value of a dollar is worth half a euro.

Now that we have discussed the principle behind exchange rates, let us tackle the principle regarding the movement of currency prices. Currency prices are not static; they are constantly on the move and they move with the slightest of changes that can affect the currency market.

There are many factors, big and small alike, that can affect the price of a certain currency but the main thing that can affect the price of a currency is the law of supply and demand. To illustrate, let's go back to the previous example of 1 euro being equivalent to 2 US dollars.

If by some chance everyone decides to buy US dollars then the value of the dollar will increase since many will want to have their hands with some dollars, causing its currency price to jack up that will affect its exchange rate with other currencies like the euro. The exchange rate of EUR/USD = 2 may change to EUR/USD = 1.5 or EUR/USD = 1 depending on the shortage of the dollar that results from the buying frenzy that ensued.

The concept of exchange rate is at the very heart of the forex market which makes it important for new traders to understand it the minute that they decide to enter the currency exchange business. There are many more intricacies that revolve around the concept of exchange rate but knowing the basics should be enough for anyone to have a fine start at the forex.