If you’ve ever asked, ‘How does foreign exchange work?’, you’re not alone.
Foreign exchange is often shrouded in secrecy—thanks to currency exchange providers hiding poor exchange rates and crazy high fees deep in card statements that you only see after the transaction has settled.
Since the foreign exchange market has many factors at play—like political events which can affect a currency’s value—it can be confusing. Plus, as an e-commerce seller, you only encounter foreign exchange briefly before you go global, so it’s easy to see why there isn’t much room to learn about it on the fly.
But it pays to understand the ins and outs of foreign exchange because it plays a huge role not just in our daily lives but in our businesses too. It affects everything from food prices to the cost of your store supplies and tools.
In this guide to foreign exchange, we’ll dig into what you need to know about the foreign exchange market to make it work for your store. Let’s jump in!
What We’ll Cover
- What Is Foreign Exchange and How Does It Work?
- What Is the Mid-Market Rate, and Why Is It Such a Big Deal?
- Why You Need to Bother with Foreign Exchange Services
- How to Find a Foreign Exchange Solution that Won’t Rip You Off and Wear You Out
- Make Foreign Currency Exchange Work for Your Ecommerce Business
What Is Foreign Exchange and How Does It Work?
Foreign exchange definition: Foreign exchange is the trading of currency. You swap one currency for another.
Foreign exchange (aka Forex or FX) involves converting funds from one currency to another. A currency’s worth changes (floats) regularly because it depends on supply and demand in the global markets.
Other factors that affect currency strength include:
- Natural disasters
- National emergencies
- Economic events (e.g., recessions)
- Import and export prices
Some countries work with a peg policy. This is where a government establishes a set exchange rate for its currency with another foreign currency or group of them. Countries with weak currencies often peg theirs to a more widely used currency like the US Dollar (USD) to stabilize it.
The electronic, behind-the-scenes nature of foreign exchange causes it to go unnoticed, and many are unaware of its vital role. Foreign exchange can turn an expensive import into a total steal overnight if the currencies fall low enough—and vice versa.
To bring you up to speed, here are few interesting facts about the foreign exchange market from the Bank of International Settlements (BIS):
- USD is the dominant currency and pegged to 88.3% of all foreign exchange transactions.
- The Euro is the second most traded currency and is on one side of 32% of trades, and the Japanese Yen holds the third spot, being on one-side of 16.8% of trades.
- The biggest markets for foreign exchange trading are the United Kingdom, Hong Kong, Singapore, and Japan who processed 79% of trades in 2019.
- More than 170 currencies are traded on the Foreign exchange market.
What Is the Mid-Market Rate, and Why Is It Such a Big Deal?
The mid-market rate is the middle figure between the buy and sell cost of two currencies at any time. The two parties involved on either side (buy/sell) are the banks and the Forex traders. The mid-market rate is a fluid rate dictated by a currency’s supply and demand, and businesses use it globally.
There are a few key things to note about the mid-market rate:
- The mid-market is critical to your Amazon FBA business‘ cross-border activities securing the best rate as it’s the fairest exchange.
- The mid-market rate serves as an accurate guide for how much you should be getting for international transactions. The currency exchange rates you get shouldn’t stray too far from the mid-market rate.
- You can’t get the exact mid-market rate for your business transactions because financial institutions add their cut, known as exchange rate margin. It’s how they profit from offering foreign currency exchange.
- The exchange rate margin can be as low as 0.1% but can hit a whopping 10%. The average is 0.4%-0.6%.
- You can use the mid-market rate to weed out exorbitant fees and find your perfect match.
To put it bluntly, if an exchange rate veers too far from the mid-market rate, it’s a ripoff, even if it’s completely legal.
Why You Need to Bother with Foreign Exchange Services
If you struggle to see the upside to converting currency in your business, you’re not alone.
At first glance, it seems like busywork. After all, your bank will do it for you, right?
While this is true, there’s one huge problem—the banks aren’t your allies. They have some of the worst rates on the market, and many will charge a foreign transaction fee of 3% plus an extra 3-5% on the mid-market rate (aka the interbank rate) on the day your transaction is processed.
To put this into context, if you receive $20,000 in funds and want to change it into British pounds, the bank would slice off $1,200, and you could lose more money if the exchange rate is terrible.
Even if you use your sales channel’s currency conversion service, you can bet you’re getting a bad deal. For example, Amazon’s Currency Converter Service total fees can be as high as 2.4%.
To make matters worse, Amazon will only pay you in the currency where you have your bank account, so many sellers have to open multiple bank accounts in each country if they don’t want to convert funds. Say you’re a UK seller selling in the US: you get paid in USD and must convert some of the funds into GBP to manage your operations from your home territory. However, you don’t want all the funds back in GBP from Amazon as you need to pay your supplier in China in USD. Just imagine how much time you’ll spend managing this mess! It’s busywork every seller could do without.
The truth is, the best rate isn’t just going to fall in your lap. You have to get out there and find it. But trust us, the search will be worth the time investment.
Here are just a few of the positives you’ll encounter with a foreign exchange service:
- Savings on savings: Thanks to the partnerships and connections foreign exchange companies have, they can secure competitive rates you wouldn’t be able to get out there on your own or through a big bank.
- Take the cap off your foreign sales: If you only charge in your home currency, it can deter some of your site visitors from making a purchase. When you have access to a fair foreign exchange rate, it allows you to serve more of your Amazon customers globally by accepting their currency.
- Give shoppers a memorable customer experience: A foreign currency exchange service can also serve your customers by helping them bypass their own foreign exchange. This is so powerful it could be what sways them to choose your store over another and keep returning.
- Get in your supplier’s good books: When you pay your supplier, it’s win-win for all. You know the rate to pay for your goods upfront, and they dodge costly foreign transaction fees on their end. Since this method is economical for the supplier, you have more wiggle room to negotiate discounts and a higher chance of securing deals.
With benefits like this up for grabs, using foreign exchange in your e-commerce business becomes a no-brainer. The question then becomes ‘How do you get the best foreign exchange rates?’ Let’s find out.
How to Find a Solution That Won’t Rip You Off and Wear You Out
Now we know how foreign exchange works and the importance of foreign exchange and mid-market rate in your e-commerce store, it’s time to hit the digital streets.
There are a few non-negotiable requirements your provider should meet. Let’s break these down:
- Shop around for a transparent provider
Don’t get caught out by ‘zero commission,’ ‘no fee’ deals. Foreign exchange companies always charge a premium, it’s just that some choose to hide it in the exchange rate. To avoid getting sucked in, look at a service that breaks down exactly what you’re getting from the exchange rate and conversion fees.
For example, at SellersFunding we take transparency a step further than most providers on the market. We always share the current market rate, our conversion fees, and exchange rate with our clients, so there are no nasty surprises.
Warning: Be mindful of where you send money and the vehicle you use, which can affect the cost. For example, SWIFT transfer and wire transfer fees often increase depending on the end destination.
- Ensure the foreign currency exchange service is custom-made for businesses
The average foreign exchange rate compared to a registered company’s can differ significantly because of factors like transaction volume and frequency—so, you’d be doing your business a disservice by going with a provider that caters to the public.
Find a solution that works with companies (preferably eCommerce companies) to secure the best deals.
- Look for a solution that holds multiple currencies simultaneously
As an e-commerce seller, you’re stretched for time, and the last thing you want to do is fiddle with numerous worldwide bank accounts.
Save yourself time and effort by looking for a foreign exchange solution that allows you to store and trade in multiple currencies from one account. It’ll bring more transparency into your company’s money management and avoid mistakes like paying a supplier twice from two separate accounts.
- Watch the markets
The foreign exchange market is notoriously volatile and sensitive to world events, like politics and economics. For example, when the UK government first announced the Brexit decision in 2016, the British pound fell to a 31-year low.
Before you make any large transactions, check the news for any developments that may cause your desired currencies to spike or plummet, examine rates over time, take note of any trends, and use a foreign exchange calculator to verify your findings. This will help you decide whether it’s best to wait or act to get the best rates.
- Use popular currency trading pairs
For the best foreign exchange rates, keep note of the most common currency pairs (where currencies have been pegged to each other) and trade in them wherever possible.
It may take multiple currency exchanges in separate transactions to preserve your funds and obtain the optimal rate.
Make Foreign Currency Exchange Work for Your Ecommerce Business
Whether you’re an e-commerce veteran or a newbie, international exchange rates and fees can be confusing.
Until transparency in the currency exchange industry becomes the norm, ‘How does foreign exchange work?’ will remain a common question. You need to be your company’s greatest advocate to hunt down the best deals, mimic the markets by being flexible, and stay in the know of the latest world news to make timely decisions.
As an e-commerce seller, your to-do list is constantly growing, so you’ll need all hands on deck to secure top rates—especially since your sales channel provider isn’t going to help (their fees can be some of the highest on the market).
When you find a foreign exchange solution you can trust, it can significantly slash your research time. But each day you leave international transactions in the hands of sneaky currency exchange providers, you’re losing precious funds. So, get busy and reclaim your funds today!
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