A forex quote holds a great deal of information that you need for your forex trading. It’s not a complex concept, but it’s one that you will need to understand.
This is a basic forex quote.
This means, of course, that one euro is equal to 1.0717 US dollars. Each euro you spend to buy dollars will give you that amount.
So the standard format for a currency pair is x/y, as above. Note the four decimal points – the last one is referred to as a pip in almost all currency pair quotes except that of the Japanese yen – that currency is quoted to two decimal points (and the pip is the last one).
In the above formula, x is referred to as the “base” currency, and y is called the “quote” (or sometimes the “counter”) currency.
You will usually see forex quotes in a more expanded form:
This forex quote encompasses the “bid” price and the “ask” price. The first price – 1.0717 – is what you can buy euros for. It is the price at which the forex trader will enter the market when selling the currency pair. The second price – 1.0725 – is what you can sell one euro for with dollars. It is the price which the trader will enter the market when buying the currency pair.
When you are buying the base currency, probably because you think it will increase in value, then you are selling the quote currency and you are also entering into what is called a “long” position. If you instead sell the base currency and buy the quote currency, you are going into a short position.
Direct and Indirect Quotes
There are two types of currency quotes in forex: Direct quotes and Indirect quotes. A direct currency quote is simply a currency pair in which the currency of the country you live and work in is the quoted currency; an indirect quote is a currency pair where the local currency is the base currency. So if you live in the U.S., and you’re looking at USD/GBP, the direct quote would be USD/GBP, while an indirect quote would be GBP/USD. The direct quote varies the domestic currency, and the base, or foreign currency, remains fixed at one unit. In the indirect quote, on the other hand, the foreign currency is variable, and the domestic currency is fixed at one unit.
Most traders, however, don’t make all their trades based on their local currency. You might start out that way because you have a better sense of trading the money you use to buy things with. But you’ll soon see opportunities in what are called “cross currency” trades, in which the dollar is not a component. If you have a good sense of international economic affairs and follow the forex economic calendar, this kind of forex trading can be quite profitable.
What is the spread?
The difference between the bid price and the ask price in a forex quote is called the spread. In the previous example: EUR/USD, the spread is 8 pips. A pip may seem an incredibly small amount, but if you’re trading a few million in the forex market, even a half-pip movement makes a pretty considerable difference.
Most brokers in the forex market do not take commissions on trades. Instead, they earn their profit with the spread. You will conclude from this that, the wider the spread, the more the broker makes, but that’s not how it works really. A broker who gave really wide spreads would quickly lose all his customers. Brokers compete on spreads, and you should compare spreads when choosing a forex broker.
Part of the strategy of spreads is based on the kind of currency pair being traded. When it’s a major currency pair, with trillions being exchanged every nano-second, brokers narrow the spreads. When it’s an exotic currency pair, in which there may not be much liquidity, brokers widen the spreads to make up for the lack of business.
From a forex trader’s point of view, when you make a trade, you have to start out by beating the spread before you see any profit. If the currency pair you are interested in trades with a wide spread, you must consider that the trade will earn a lot of pips before you can break even. You must calculate your strategy with this in mind.
Use of lots
Another aspect of currency pairs is the use of lots. To facilitate trading, brokers don’t trade make a single trade at one time, they group them into lots. The standard lot is valued at $100,000. There are also smaller lots with a size of $10,000 called mini-lots, or $1,000 called micro lots. Because most trades are intended to profit from small movements of currency pairs, only a few pips at a time, these large lots of currency are put together to take advantage of small price movements.