How Forex is Priced and Why it Moves

Forex is traded in pairs. The value of a currency is derived relative to other currencies. This is shown in a format such as ‘GBPUSD’ or ‘USDCAD’ – meaning ‘Pound versus Dollar’ or ‘Dollar versus Canadian Dollar’. The first currency (or ‘base’ currency) is compared to the second currency (or ‘quote’ currency). Currencies have no intrinsic value, unlike stocks which have balance sheets and tangible assets. This is was necessitates the ‘relative’ style of valuation. If the quote of GBPUSD is ‘1.4’, this means that 1 GBP is able to buy 1.4 USD. The ‘base’ is 1 and the ‘quote’ is 1.4.

Why does forex move?

Now that we know how forex is priced, we need to know why forex moves. Put simply, forex moves for the same reason all markets have changes in price – supply and demand. The reasons behind this supply and demand are beyond the scope of the article. Supply and demand can be driven by fundamentals or technicals.

Markets tend to move in cycles – trending and ranging. A trending market is one which is tends to move in a specific direction. This can be easy to spot but difficult to make rules for. A ranging market is one which stays in roughly the same place, moving sideways. Again, relatively easy to spot. It looks like a rectangle or box of price, defining the boundaries of the range.

A stock chart which shows a range and a trend

 

The chart shown is a stock chart, not forex. However, the premise of trend and range is equally as valid on a stock chart and can be seen clearly. We can see that the white box labelled ‘ranging’ is quite clearly defined by its extremities. The orange arrow labelled ‘trending’ is also quite clearly a directional move.

The concept of trend and range will become very important in your trading. It has been touted that markets range 70% of the time and trend for the remaining time. I haven’t personally researched those statistics but believe it to be roughly accurate. However, if we think about the fractal nature of markets, on different timeframes we could consider markets to be both trending and ranging at the same time. This is another important concept which we will go on to learn.

Next article: Setting Up To Trade.