FX markets basics

- [Instructor] A riskier and more advanced option for investors that want to speculate, is FX, or the Foreign Exchange Market. Now, the best way to understand the basics of FX, which is what I want to talk about here, is just to look at an example. So, I've started with a page you're probably all familiar with, Google. And then I've simply typed in USD to EUR graph. And this is what pops up. Now, what do I mean when I say USD to EUR? This refers to two major currencies. The US dollar, which is the currency for the United States, and EUR, which represents the euro, the currency for the eurozone. Now, what this chart is showing us is that the exchange rate between US dollars and euros is 0.88. What that means is that if you were to take one US dollar and convert it into euros, you would get 0.88 euros. 100 US dollars would buy you 88 euros. Now you might ask, "Well, how does that work?" The reality is, those exchange rates are driven by the strength in each relative economy. As the US dollar strengthens, that exchange rate will strengthen. US dollars become stronger, meaning they buy more euros. Now, if we were to go from euros to, say, Japanese yen, watch what happens. Well the Japanese yen is much less valuable than the euro in comparison to the dollar. Now that doesn't mean anything, of course. It's just a paper denomination. But one dollar buys you 108.13 yen. Of course that doesn't mean much, because one yen doesn't buy much in the way of goods in Japan. One euro will buy sort of a lot in the eurozone. One dollar will buy sort of a lot in the United States. In relative terms. Now, these exchange rates are not constant. If we turn to TradingView.com, we can take a look at how exchange rates have fluctuated over time. And I'll just look at a one year chart. What we see is the US dollar euro exchange rate has actually been strengthening over this period. A year ago, the US dollar would have only bought about 0.85 euros. Today it buys about .88. Why is that? Well because relatively speaking, the US economy has gotten stronger compared to the eurozone. Both economies are growing, neither one is in a recession, but the US economy is doing better than the eurozone economy is doing. As a result, that exchange rate is strengthening. Now, what you probably notice here is that over the course of a year, we're talking about a very very tiny change. A year ago, 100 dollars would have bought 84, 85 euros. Today, 100 dollars buys 88 euros. It's not a big difference. Yet, FX is still a major market for investors. Why is that? Well, a couple of reasons. Number one, companies use the FX markets to help hedge their risk. If I'm, say, Toyota, selling cars in the United States, well what I really want is my profits repatriated back to Japan in the form of Japanese yen. So I can use the FX markets to protect me against risks involved in the changing in exchange rates. But from the investor side, we could also invest based on exchange rates. We might say, "You know, I think that the US dollar "is going to continue to get stronger. "I think this exchange rate is going to keep rising. "So I want to capitalize on that "by selling euros and buying US dollars." If the exchange rates strengthen, I can convert back to euros in the future, and I'll be better off. But I'm going to have to do this for a very large sum, notionally. In other words, if I do this for 100 bucks, I'll make three euros over the course of a year. For that reason, FX traders often use what are called futures contracts, which lets them lever up. They can trade a million dollars at a time, even if they only have a few thousand dollars in their own personal bank accounts. That's the power of leverage in the FX market. Trading FX is about trading expectations on the economy. It's very risky, and small changes get magnified a lot through the power of futures. Now, you should have a good handle on the basics of FX markets.