Basic Introduction to the Forex - Part 2

Forex Currencies are always quoted in Pairs (as mentioned earlier) In the USD/EUR pair, the first currency (USD) is called the base pair. The second currency (EUR) is called the counter/quote currency. The exchange rate tells you how much of the counter/quote currency you can get in exchange for 1 unit of the base currency So USD/EUR = 1.75 implies you buy 1.75 euros for every U.S Dollar sold. Basically, when we refer to buying or selling we refer to the base currency. Whereas in reality two actions occur (that is when you buy the base currency you sell the counter currency and vice versa) So to make matters simple, you buy when you expect the exchange rate to rise, and you sell when you expect the rate to depreciate. Buying/Selling Buying (or going LONG) simply means buying the base currency anticipating the price to rise reasonably Selling (or going SHORT) simply means selling the base currency in the hope thata the price will fall reasonably So,LONG = BUY and SHORT = SELL Spread The Spread is the difference between the bid and the ask price The bid is the price in which the dealer is willing to buy the base currency in exchange for the quote currency. This means the bid is the price at which you will sell. The ask is the price at which the dealer will sell the base currency in exchange for the quote currency. This means the ask is the price at which you will buy. This is the way through which forex brokers earn their comission and spread is one of the factors that can decide a good broker (more on that later) For Eg: USD/EUR 1.7502 1.7506 The first price is the bid price, the second price the ask price. You will buy USD/EUR for 1.7506 and sell it for 1.7502. Spread in this case is 4 pips. Pips Suppose USD/EUR = 1.7502 After ten minutes USD/EUR = 1.7504 The increment is 0.0002 or simply 2 pips A pip is the smallest value a number can move, in this case (and for most cases as well) one pip is equal to 0.0001 A notable exception is the USD/JPY, where the value of the pip is 0.01 Calculating Profit and Loss This is one thing you really do not have to worry about, most forex software will calculate it for you, but then it is always better to know how to do it ! Assuming USD/EUR 1.7502 1.7506 You sell 100,000 USD, hence the exchange rate that would apply would be 1.7506 (ask price) Later USD/EUR 1.7526 1.7530 You reverse and sell the Euro, but now the rate that applies would be 1.7526 (bid price) Now the profit you make = 1.7526 - 1.7506 = 20 pips Calculating the value, we have the value of 1 pip as 0.0001 / 1.7526 = 0.0000570 And assuming you traded 100,000 units, value per pip = $ 5.70 Which into your 20 pip profit = $ 114.1 However, in the forex you can borrow and sell more by using MARGIN TRADING. However we will discuss that later Continue to Basic Introduction to the Forex - Part 3 (Leverage) Go Back to The Forex