Foreign currency exchange is simply the process of changing one currency for another. The concept is a basic one, but what happens on the markets is a little less straightforward. However, once you know more, you’ll see that some of the things that make foreign currency exchange a little confusing, can be harnessed to help you protect your funds and get more from your money with a better exchange rates.
What is Currency Exchange?
Foreign exchange (which can also be referred to as ‘forex’, ‘currency exchange’ or ‘foreign exchange’) involves converting one currency into a sum of equivalent value in another currency.
Currencies are not equal, which is why you need an exchange rate to tell you how much the currency you have (known as the ‘base’ currency) is worth in relation to the one you want to purchase (called the ‘quote’ currency). The exchange rate is presented as a ratio, so if the current exchange rate for converting Pound Sterling in Canadian Dollars is 1.9663, that means that for every 1 Pound you exchange, you would receive 1.9663 Canadian Dollars.
There are over 200 different currencies in circulation and each one is identified by a three-letter ISO code which is generated from its country of origin and the currency name. So Pound Sterling has the code GBP, the Canadian Dollar is CAD, the Australian Dollar is AUD and the New Zealand Dollar is NZD.
Currencies are always traded in pairs and exchange rates are presented as the two currency codes, with the base currency first and the quote currency second. So if you were wishing to trade Pound Sterling for Australian Dollars, the exchange rate would be presented as GBP/AUD, followed by the ratio.
Why do Exchange Rates Change?
Currencies are constantly changing in value, with everything from economic performance to commodity prices affecting its developments. Economic performance, data, politics and global events can all change a currency’s value. The strength of a country’s economy is one of the key drivers in exchange rates; a country which is performing well is going to have a more desirable and valuable currency than a country which is currently struggling.
Often, key commodities can drive exchange rate movements. If a commodity is particularly vital for a country’s economy, a drop or climb in prices will have widespread consequences. For example, the Canadian Dollar’s value is heavily dependent upon the value of crude oil because it is Canada’s main export, while the Australian Dollar is linked to iron ore prices and the New Zealand Dollar to the price of milk.
Data is always being released, experts are always commenting and forecasting, politicians are constantly making promises or policy alterations and freak weather events are forever hampering trade and agriculture, so exchange rates can fluctuate on a daily or even minute-by-minute basis. This constant change in value is why people are increasingly choosing to use an international money transfer provider (also known as a currency broker) to help them manage their transfers.
The amount exchange rates can move within such a short period is what makes it vital that you choose to trade at the right time. For example, if you were to trade £100,000 into New Zealand Dollars at an exchange rate of 2.1574 you would receive NZD$215,740. But if the markets moved in your favour and you traded your money at a later date with a GBP/NZD exchange rate of 2.2248 you would receive NZD$222,480. That’s NZD$6,740 extra just for trading at a better rate.
Should you use a bank or a currency broker for foreign exchange?
Many people automatically think that a bank is the best place to go in order to exchange currencies, but this isn’t always the case. Reputable currency brokers may be able to offer you a much better deal compared to a high street bank and a more personal service.
A currency broker can offer you many things that a bank often can’t, including dedicated currency specialists, your own account manager, fast, free transfers and exchange rates that undercut those offered by banks by up to 90%. Currency brokers are able to do this because they typically add a smaller margin to the currency they buy from the interbank market than high street banks do and they pass this saving directly on to you.
Additionally, because currency brokers are solely focussed on forex, where banks handle lots of different services, they can often offer you a much more in-depth and attentive service.
Leading brokers make it easy to register and you have no obligation to trade. It can be useful to create an account so that you can benefit from a broker’s in-depth market insights and updates which help you make an informed decision regarding when to carry out your transfers. You will also benefit from having access to a range of transfer services and the option of using an online platform to make your transfers 24/7. Your account manager will handle all the details of the transfer for you, making the process quick and convenient.
It usually only takes one or two working days to complete a transfer, although the currency in question and the location of the destination account can affect the process.
What are my options when exchanging currency?
If you go to a bank for your currency transfers, you will probably only be offered a ‘spot contract’. This is an immediate transfer using the relevant exchange rate at the time.
Currency brokers can offer you several other options which could better help you to meet your needs and get the most from your money. For instance, a broker can offer you a ‘forward contract’, which essentially fixes an exchange rate for a period of up to two years. This means you can protect yourself from developments in the market and ensure you know exactly how much money you’ll receive. This is particularly useful if you are planning a large purchase overseas in the future as it allows you to budget effectively.
You could also ask your broker to set up a ‘stop loss order’ or ‘limit order’. A ‘stop loss order’ sets a minimum exchange rate you are happy to transfer your funds at. This way you are free to hold out for a better rate, but if the market goes against you your funds will be automatically transferred should the exchange rate fall to the level specified by your ‘stop loss order’.
A ‘limit order’ works the other way round, setting a target rate that you want to achieve. Your funds won’t be exchanged until that rate is hit, so you can wait for a rate that is more beneficial to you and know the transaction will take place as soon as that rate is reached. You can even use a ‘stop loss order’ and a ‘limit order’ together to ensure your transfer is kept within a certain range.
Get more information on foreign currency exchange
If you have questions about foreign currency, you might like to get in touch with a reputable international money transfer provider. They will be happy to talk you through your options and answer any questions you might have. You can get leading market insight and advice for free, helping you to decide on the best time and method to transfer your currency.