To get to the heart of forex trade, you have to understand what currency pairs are and how to manipulate them to make profits. This overview will briefly instruct you on the matter so that you knew what information on forex currency pairs to explore in-depth.
Why do currencies go in pairs, to begin with?
If you want to buy something, you have to pay for it with money, be it paper bills or silver coins (where they are still minted), or even electronic payment units. You get the stuff, and a seller gets your money.
But how do you buy money? The principle is the same: you get the currency you need in exchange for another currency. That’s why it’s called forex – it stands for foreign exchange. So, when you see the forex pair you know immediately that you can buy this specific currency with the help of another one. Like, euro to dollar pair, dollar to British pound pair, and so on. You buy Euros and pay for them in dollars. It’s that simple.
Another important concept: in such a pair, currencies have their own names. In a pair EUR/USD, if you buy euro and pay with dollars, the first currency is the base currency, and the second currency is the quote currency. EUR is a commodity, so to say, and USD is the unit to measure the price of that commodity.
Coming to terms with Quotes and FX rates
Now we smoothly transition to the idea of quotes. When we express the exchange value of one currency through another one, we get a quote. For example: in your trading account, you see the quote EUR/USD 1.21235.
How to decipher it? It is not that complicated: at a given moment, one EUR costs 1.21235 USD. That’s all. From this point, you can proceed to the assessment of your trading balance and how many EUR you can buy at this rate with your hard-earned dollars. This rate is called the FX rate, and it is based on this rate that you make your trading decisions. So far so good.
Buying and selling prices and the scary ‘spread’ word
Now the next question: why do you see in your account not one quote but two for the same currency pair? It happens because there are two FX rates for each currency pair: a buying and a selling price. Yes, you buy the currency at one rate and sell it at another one. These rates are called the ask price and the bid price correspondingly. Usually, the ask price is higher than the bid price, and it is normal.
For example, for the pair EUR/USD the ask price for EUR will be USD 1.21236, and the bid price will be USD 1.21235. Yes, after conducting a successful trading operation and making some profit, when you convert back to dollars, you lose a portion of profit by default. Hence, calculate well in advance how much the profit should be so that you earned something after paying this exchange fee.
Where does this practice come from? A broker (in our case, a forex platform) needs to make a profit from your transactions, that is, get a commission and some maintenance fees. The difference between buying and selling prices constitutes this commission and is called a spread. Obviously, the platform friendliest to traders is the one where a spread is minimal and you pay only a modest part of your earnings as a trading fee.
How to calculate a spread? It is simple math: you take a higher rate and subtract a lower rate from it. 1.21236 – 1.21235 = 1. The spread equals one. This is a generalized example of a spread, since there are different types of spreads charged, and for various currency pairs they will have different values. That’s the point you have to study in depth before you actually start trading on a chosen platform.
Currency pairs and their popularity
The idea of different spreads for different currency pairs leads us to the next concept: major and minor pairs. What is the difference? The answer is their popularity with traders around the globe. The bigger the currency’s volume of trades, the higher the position in ratings (and the lower the spread). The pairs that make up around 90% of all trades are called major pairs, and those that are traded rarely are called minor pairs. Each kind of pairs is useful for achieving specific trading goals, like gaining short-term or long-term profits.
As you can guess, among major trading pairs, most pairs are linked to US dollars. You can find options of trading euro to US dollar (EUR/USD), US dollar to Swiss franc (USD/CHF), British pound to US dollar (GBP/USD), Australian to US dollar (AUD/USD), US to Canadian dollar (USD/CAD), US dollar to the yen (USD/JPY). Two other major pairs include the yen as a quote currency, that is, euro to yen, and the British pound to yen pairs.
Less popular or minor pairs include New Zealand dollar to yen, euro to the Australian dollar, British pound to the Canadian dollar, and some more.
There are also exotic currency pairs that are underrepresented because of low interest, but trading in them can pose interest for experienced traders.
Direct quotes vs. indirect quotes
A direct quote is the price index that is expressed in the main currency of your account. If your account is using the dollar as the main currency, the quotes that will include dollars will be direct quotes for you. If the quote relies on other currencies, this quote will be an indirect one, because first, you have to convert your dollars into the quote currency of the pair and then buy the base currency. It sounds a bit complex, but once you do it, it becomes clear and simple.
The idea of a currency pair and accompanying concepts is central for forex trading. So before you open a real account, study the theory in-depth and get some demo practice.
· in a pair, one currency is base (the one you buy) and another one is a quote (the one you pay in);
· the cost of a base currency in units of the quote currency is (you get it) a quote;
· there is an ask price (quote) and a bid price (quote);
· ask price minus bid price equals is a spread;
· there are major and minor pairs;
· there are direct and indirect quotes.
With this basic understanding, you can proceed to explore more complex ideas and trading strategies and become an experienced and profit-making trader.
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