Ever wonder what all those numbers mean at your broker’s website? Don’t worry, we will explain everything in grueling detail for the very beginner. Let’s begin learn more about forex basics.
Instrument And Variable
What is a currency pair?
Unlike stocks, foreign exchange allows to buy one currency in exchange for another. The currency pair indicates which currency you are buying and which ones you are selling. These are the four major currency pairs and are the ones you should begin trading with:
These are the most heavily traded currency pairs and therefore, they are the most liquid, and typically have the lowest spreads.
Digging Deeper into Currency Pairs
Let’s take an example:
EUR/USD = 1.5673
Base currency: EUR
Quote Currency: USD
What does this mean? It means it will take you 1.5673 US dollars to buy one Euro. The base currency is always the first currency in the pair, which will always be have a unit of 1. The price is how much of the 2nd currency pair it will take to buy one unit of the first currency pair.
A pip is the smallest unit of a price change. If the EUR/USD rises 0.0001, we say that it went up one pip. So if you bought the currency pair at 1.5673 and sold it at 1.5680, you have gained 8 pips. The more pips you gain, the more money you make.
It would be nice if you can buy and sell the currency at the going exchange rate. Unfortunately, life is not that easy. Let’s take the same example:
EUR/USD = 1.5673 / 1.5675
Base Currency = EUR
Quote Currency = USD
Bid Price = 1.5673
Ask Price = 1.5675
So what exactly is the bid and ask price? Sometimes the bid price is referred as the buy price, and the ask price is referred as the sell price. This is a bit misleading since this refers the market’s buy and sell price, not yours.
The bid price is what the market is willing to buy the currency for, which actually means it is your selling price. So if you wanted to unload the EUR/USD pair, you would sell it at 1.5673.
Conversely, the ask price is what the market is willing to sell the currency for, which equates to your buying price. You will buy it at the price of 1.5675, or the ask price.
Sometimes the Bid/Ask price is expressed in this format:
EUR/USD = 1.5673 / 75
This has the exact same meaning as above, only written in a different format. Once again, it means the bid price is 1.5673, and the ask price is 1.5675. The ask price is just showing the last two digits because the first 3 digits are the same.
The definition of a spread is the difference between the ask price and the bid price. A good spread is between 2-4 pips. The spread for the above example is 2 pips. Why is a low spread better?
If you bought EUR/USD at 1.5675, and immediately decide to sell it at the exact same moment, you can only sell it at the bid price of 1.5673, which means you lose 2 pips. If you wanted to break even, you will have to wait until the ask price rises from 1.5673 to 1.5675 before you sell it.
A low spread is vital to your success. A high spread takes out a big chunk of your profits each and every trade.
You have learned the basics terms and definitions of foreign exchange. You can now read and understand the numbers that appear on any forex website. Learning the forex basics is only the start. Continue to build on your knowledge to succeed in this game.