Investors all over the world are flocking to FX trading. This relatively new market is one of the largest and most fluid in the world, and offers 24-hour-a-day trading that should excite any investor, from beginner to pro. If you’re looking to start trading on the FX market, knowing some of the jargon will help you toward success. Read on to learn about some of the terms that are commonly used in FX trading, and how those terms can affect you and your money.
FX trading, or Forex trading, is the trading of world currencies on the foreign exchange market. Unlike other large markets, like stock exchanges, the foreign exchange market isn’t an actual place; all trades take place online. Because businesses that operate internationally need to exchange currencies almost constantly, the foreign exchange market operates 24 hours a day, five and a half days a week, in major financial hubs in almost every time zone: London, New York, Tokyo, Zurich, Frankfurt, Hong Kong, Singapore, Paris and Sydney. Since businesses and individuals need to exchange currencies almost constantly, the foreign exchange market is the largest, most liquid financial market in the world, trading more than the equivalent of $4.9 trillion US dollars each day.
The name hawkish comes from the bird “hawk,” which is known for being a fast and deadly predator. However, when talking about finances, the term comes with a bit more nuance. In the FX world, “hawkish” refers to an economic outlook in favor of high interest rates.
For example, if a US Federal Reserve speaker is called hawkish, it might signal that interest rates on the US dollar are headed for a rise. While higher interest rates may mean less money in consumer pockets, it means a higher return rate for those looking to invest. As such, an interest rate hike is generally good news for traders, because it means foreign investors will be more interested in buying that currency. More investors purchasing a particular currency increases the demand and, thus, the value of the currency.
The name dovish comes from the bird “dove,” which is known for being docile and gentle. In the financial world, “dovish” refers to an economic outlook that sees keeping interest rates low as a way of encouraging economic growth. When interest rates are lower, it means consumers literally have more money to spend. As such, dovish people believe the negative implications of low interest rates, for example, in reference to currency traders, are negligible over time.
If members of the US Federal Reserve are dovish, it would mean that they are in favor of lower interest rates. Dovish speeches by Federal Reserve members, for example, may be an indication that interest rates on the US dollar may drop after the next FOMC (Federal Open Market Committee) meeting.
All other factors being equal, higher interest rates, which hawkish policy is in favor of, increase the value of a currency and can drive up its exchange rate in currency pairings. With all the same factors, lower interest rates, or dovish rates, would lower a currency’s overall value. This is in large part because high interest rates that can be earned encourage foreign investment in a currency, increasing the demand for and value of the currency, while lower interest rates are going to be less attractive to investors. However, exchange rate calculation isn’t usually that simple.
Higher interest rates often lead to inflation, which decreases the value of the currency and lowers its exchange rate. A country’s debt is also a factor, since high debt can also lead to inflation. If a country is stable and has a high gross domestic product (GDP), demand for its currency will be higher, which can also drive up exchange rates.
In short, hawkish and dovish policies can affect a currency’s exchange rate, especially on the short term. If a currency is expected to be hawkish, or increase interest rates in the near future, its exchange rate will probably take a short term jump. But if it’s expected to be dovish, or decrease its interest rate, its exchange rate will likely go down for a time. But there’s a whole host of other factors that also go into determining the currency’s value at any given time, and that value can fluctuate constantly.
Exchange rates on the FX market are described as relationships between the values of 2 different currencies. For example, if a trader wants to determine the exchange rate between the US dollar (USD) and the Japanese yen (JPY), a quote might look like this:
USD/JPY = 119.50
This quote means that US$1 = 199.50 Japanese yen, so 1 USD could buy 119.50 JPY.
On the FX market, there are generally different exchange rates for currencies depending on whether you’re looking to buy them or sell them, so quoted exchange rates on the FX market will almost always differ from the mid-market rate, which is the actual exchange rate for the currency determined by the midpoint between supply and demand for that currency. The mid-market rate can be called many things. Interbank rate, spot rate, mid-market rate, they are all the same thing. They are also the rate you’ll see if you Google 2 currencies.
When buying currency, you’ll want an exchange rate as close to the mid-market rate as possible, because that means you’re getting a good deal on your buy. When selling, you’ll want to quote an exchange rate a little higher than the mid-market rate to get more money for the currency you’re selling.
For FX traders, a good tool to consider is a TransferWise borderless account, a multi-currency account which allows users to hold, trade and manage money in up to 27 different currencies all at once, with more currencies being added constantly. Most traditional bank accounts only allow their users to keep 1 or 2 of currencies at a time, which can complicate FX trading. A TransferWise borderless account can solve that problem.
Borderless account holders will also soon have access to consumer debit cards, which will allow for easy spending from borderless accounts in multiple currencies in countries all over the world.
Whether you’re already a seasoned FX trader or just interested in making your first trade, you’ll want to stay on top of the current exchange rates to compare to quotes, ensuring that you’re getting the best deals on the FX market. If you want to keep a close eye on rates, signing up for a tool like TransferWise rate alerts can help.
FX trading is a new and exciting world for investors, and knowing terms like these ones will help toward any new trader’s success.
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