Understanding fundamentals: The Forex Exchange Market

The foreign exchange market is a decentralized market essentially for trading currencies. This is one of the most geopolitically driven market, as even the slightest amends in governmental policies could drastically shift market sentiments, depending on the policy and/or situation.

Forex Exchange is essentially the market of currencies, where investors invest their money wagering what will happen to other money.

In this case, to bet against something the market would need a benchmark, a standard to which betting can be done against, this is where the US dollar comes to play.

US dollar is unarguably one of the strongest and most stable currencies in the world, it is in circulation across the world hence this made the US dollar (also the World’s Reserve Currency) a perfect benchmark for forex exchange.

Now, to better quantify and measure the US dollar it is measured against the DXY Basket. The DXY Basket consists of 6 powerful yet stable currencies called trading pairs. The currencies are as following – Euro, Great Britain Pound, Canadian dollar, Japanese Yen, Swedish Kroner, and the Swiss Franc. These currencies are the most traded internationally after the US dollar. Each of these currencies have a different weightage point, relative to the index.

Euro has the highest weightage of 57.6% followed by the Japanese Yen at 13.6%, GBP at 11.9, CAD$ at 9.1%, SEK at 4.2% and lastly CHF at 3.6%. this would mean that as the value of these currencies would go down, the DXY exchange (US dollar) would increase relative to its weightage on the DXY exchange.

Uses of the Forex exchange

- The Forex exchange market is great for hedging, this allows companies doing business in foreign countries to hedge a currency's exchange rate so it is immune to inordinate fluctuations in the exchange rate. By hedging, they are essentially fixing an exchange rate for the currency against the US dollar for the particular transaction.

- The Forex Exchange market also helps in speculation, as aforementioned the Forex market is very sensitive, factors like interest rate, tourism, economic stability and geopolitical condition very well reflect on the forex exchange rate of a country aiding potential foreign investors to assess a country before investing in it.