Forex Conversion

With so many currencies being traded on the Foreign Exchange Market, it is important to understand just how each monetary unit is converted to make trades as fair as possible.

Making Forex conversions can be exciting and fun, as you note each day the rise or fall of a specific currency depending on several factors, which fluctuate from day to day based on a variety of economic factors. Fluctuations are normally the result of actual monetary flows, as well as the expectation of changes in flows, which can be caused by changes in gross domestic product (GDP), inflation, interest rates, and budget and trade deficits. A simple formula can be used to make these conversions, shown below.

Each currency constitutes an individual product, and noted as XXX/YYY, or sometimes as YYY/XXX, where Y is the international three-letter currency code into which the price of one unit of X is expressed, commonly referred to as the base currency. A non-European currency is represented by the code ZZZ.

For example, let’s say you’re converting euros to dollars. You would begin by using the formula USD/EUR, the price of the euro expressed in dollars, where 1 euro equals 1.5465 dollar. Currently, an amount of 140,000 dollars equals roughly 100,000 euros, therefore expressed by the equation $140,000/€100,000 = $/€ = USD/EUR = a rate of 1.4 EURUSD or USD/EUR. The factors affecting XXX will affect both XXXYYY and XXXZZZ, causing a positive currency correlation between both currencies.

The euro has become one of the highest traded currencies since its inception in 1999, and many market analysts speculate whether the euro will replace the dollar as the base currency of the Forex market. Until quite recently, trading the euro versus a non-European currency (ZZZ) would involve two trades: EURUSD and USDZZZ, but as the dollar’s value decreased dramatically in 2008, a newfound interest in using the euro as reference currency for prices in commodities (such as oil), as well as a larger component of foreign reserves by banks, has become a market standard.