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This is a concept that many students find
confusing at first, but it’s actually very simple. Whenever you
enter a currency trade, there are two currencies involved. Think
about the traveler from our earlier discussion, who exchanged
his homeland’s currency for the currency of the land he was
visiting. You’ll recall that there were two currencies involved
in the transaction, but only one exchange rate.
Every foreign exchange transaction, or forex trade, involves two
currencies and one exchange rate. The best way to illustrate the
reason for this is to attempt to initiate a currency transaction
that involves just one currency.
For example, if you live in the United
States, walk down to your local grocery store and ask the person
behind the counter, “How many U.S. dollars will you give me in
exchange for 20 U.S. dollars?
After the clerk gives you a sideways look,
he’ll assume that you want change for a twenty, and $20 is
exactly what you’ll get—no more and no less. Nobody is going to
offer you more than $20 for a $20 bill, so you cannot profit
from this exchange.
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Imagine the difficulty involved in trying to
trade just one currency. Will any sane person offer more than
one British pound in exchange for another British pound?
Remember, we are not speaking about collectible coins or
interest-bearing loans, just a pure currency exchange.
Conversely, a clever trader might offer less than one British
pound in exchange for one British pound, but only a fool would
accept this proposition. This explains why we cannot trade just
one currency at a time. This is because the value of a currency
itself does not change, but its value can change in relation to
another currency. In other words, that dollar in your pocket
will still be worth $1 tomorrow; however, its value constantly
fluctuates relative to other currencies. This is why we must
trade currencies in pairs. |
