The forex market is where you buy or sell currencies. Period!
To place a trade in the foreign exchange market is like taking a stroll down the park. The process involved is closely related to those found in other essential money markets like the stock exchange. Therefore, with a little knowledge or experience in trading, you should be able to navigate your way through as quickly as possible.
The business object of forex trading is premised on the exchange of one currency for another, having the faith that the price will change.
In more precise terms, it entails the hope that the currency you bought will go up in value as against the one you sold.
Here is an example.
Pay attention to the fact that an exchange rate clearly reflects the ratio of one currency when valued against another currency.
For instance, the exchange rate of the USD/CHF shows how many US dollars can buy one Swiss franc, or what number of Swiss franc you will need to purchase a U.S dollar.
How to read and understand a forex quote
As much as currencies are concerned, they are always quoted in pairs like in USD/JPY or GBP/USD. In case you are wondering why currencies are quoted in pairs, it is down to the fact that in all foreign currency exchange transactions, you’re actively buying one currency and selling another at the same time.
Take a look at this foreign exchange rate transaction for the British pound sterling up against the U.S dollar.
Looking to the left of the slash is the first listed currency also known as the ‘base currency’, which is the British Pound in this example. On the other hand, the second currency listed to the right is known as the quote or counter currency, which happens to be the US dollar in this example.
When making a purchase, the rate of exchange tells you the amount you will have to pay, which lies in units of the quote currency, so that you can buy a unit of the base currency. In the above-mentioned example, to purchase one British pound, you will have to pay 1.51258 U.S dollars.
On the other hand, when you are selling, you will be able to know through the exchange rate how much units of the quote currency you will receive when you sell a unit of the base currency.
Going back to the example above, you will receive the same 1.51258 U.S dollars for selling one British pound.
In a nutshell, the “basis” for the buy or sell is the base currency. So, if you purchase GBP/USD, it means you are purchasing the base currency and at the same time selling off the quote currency. This is what it means when you hear the talk of “Buy euro, sell USD.”
- You will purchase the pair with the belief that the base currency itself will gain value (appreciate) in relation to the quote currency.
- You will be selling the pair if you have the faith that the base currency will lose value (depreciate) in relation to the quote currency.
Going Long or Short
The first thing is to determine whether you are going to buy or sell.
If you have made up your mind to make a purchase, it means you are committed to buying the base currency and selling the quote currency. In that case, you will wait for a rise in the value of the base currency and then you can later sell it back at much higher price.
The trade terminology used for this is called “taking a long position” or “going long.” Don’t forget that in this case, Long equals Buy.
The Concept of Bid, Ask and Spread
Every quote in the forex is quoted along with two prices namely: the Bid and Ask prices. In most cases, the bid is lower compared to the ask price.
BID refers to the price set at which the broker you’ve contacted is willing to purchase the base currency from you in exchange for the quote currency. By this, the bid represents the best price available, and by which, you (the trader) is willing to sell to the market.
On the other hand, the ASK entails the price at which the broker is willing to trade off the base currency in exchange for the quote currency. By this, the ask represents the best price available at which you are willing to purchase from the market.
Concerning the EUR/USD quote example we mentioned above, you can see that the bid price is put at 1.34568 while the ask price is put at 1.34588. You can now see how easy this broker makes it possible for you to trade off your money.
What it means is that:
- If you are interested in selling your EUR, just click “Sell” and boom! You will sell euros at 1.34568.
- If you intend buying EUR, just click “Buy” and straightway, you’ll be purchasing euros at 1.34588.
Below is a perfect illustration that demonstrates and summarise all that we have learned under this topic.
It’s about time we view some classic examples.
