Understanding Forex Quotes

Reading a foreign exchange quote may seem a bit confusing at first. However, it's really quite simple if you remember two things: 1) The first currency listed first is the base currency and 2) the value of the base currency is always 1.

The US dollar is the centerpiece of the Forex market and is normally considered the 'base' currency for quotes. In the "Majors", this includes USD/JPY, USD/CHF and USD/CAD. For these currencies and many others, quotes are expressed as a unit of $1 USD per the second currency quoted in the pair. For example, a quote of USD/JPY 110.01 means that one U.S. dollar is equal to 110.01 Japanese yen.

	What is a pip? In the Forex market, prices are quoted in pips. Pip stands for "percentage in point" and is the fourth decimal point, which is 1/100th of 1%. In EUR/USD, a 3 pip spread is quoted as 1.2500/1.2503 Among the major currencies, the only exception to that rule is the Japanese yen. In USD/JPY, the quotation is only taken out to two decimal points (i.e. to 1/100 th of yen, as opposed to 1/1000th with other major currencies). In USD/JPY, a 3 pip spread is quoted as 114.05/114.08

When the U.S. dollar is the base unit and a currency quote goes up, it means the dollar has appreciated in value and the other currency has weakened. If the USD/JPY quote we previously mentioned increases to 113.01, the dollar is stronger because it will now buy more yen than before.

The three exceptions to this rule are the British pound (GBP), the Australian dollar (AUD) and the Euro (EUR). In these cases, you might see a quote such as GBP/USD 1.7366, meaning that one British pound equals 1.7366 U.S. dollars.

In these three currency pairs, where the U.S. dollar is not the base rate, a rising quote means a weakening dollar, as it now takes more U.S. dollars to equal one pound, euro or Australian dollar.

In other words, if a currency quote goes higher, that increases the value of the base currency. A lower quote means the base currency is weakening.

Currency pairs that do not involve the U.S. dollar are called cross currencies, but the premise is the same. For example, a quote of EUR/JPY 127.95 signifies that one Euro is equal to 127.95 Japanese yen.

When trading forex you will often see a two-sided quote, consisting of a 'bid' and 'ask':

The 'bid' is the price at which you can sell the base currency (at the same time buying the counter currency).
The 'ask' is the price at which you can buy the base currency (at the same time selling the counter currency).

Basics of Forex

The following is an introduction to some basic terms, definitions and concepts used in forex trading.

Introduction

Foreign Exchange

The simultaneous transaction of one currency for another.

Foreign Exchange Market

An informal network of trading relationships between the world's major banks and other market participants, sometimes referred to as the interbank market. The foreign exchange market has no central clearinghouse or exchange, and is considered an over-the-counter (OTC) market.

Spot Market

The market for buying and selling currencies at the current market rate.

Rollover

A spot transaction is generally due for settlement within two business days (the value date). If you open a position on Monday, the value date is Wednesday, but if you hold it past rollover on Monday, the new value date is Thursday. Every margin transaction involves borrowing one currency to purchase another, so you pay interest on the currency borrowed, and earn it on the one purchased. For example, if you buy the NZD (7.5% interest rate) and sell the JPY (0.5% interest rate), you would earn interest on the NZD and pay it on the JPY. The amount you pay or receive is based on the interest rate differential between the two currencies. Most brokers automatically roll over your open positions (usually 5PM New York time/10PM GMT) allowing you to hold your position for an indefinite period of time.

Exchange Rate

The value of one currency expressed in terms of another. For example, if EUR/USD is 1.3200, 1 Euro is worth US$1.3200.

Currency Pair

The two currencies that make up an exchange rate. When one is bought, the other is sold, and vice versa.

Base Currency

The first currency in the pair. Also the currency your account is denominated in.

Counter Currency

The second currency in the pair. Also known as the terms currency.

ISO Currency Codes

USD = US Dollar
EUR = Euro
JPY = Japanese Yen
GBP = British Pound
CHF = Swiss Franc
CAD = Canadian Dollar
AUD = Australian Dollar
NZD = New Zealand Dollar

For a full list, see ISO Currency Codes

Currency Pair Terminology

EUR/USD = "Euro"
USD/JPY = "Dollar Yen"
GBP/USD = "Cable" or "Sterling"
USD/CHF = "Swissy"
USD/CAD = "Dollar Canada" (CAD referred to as the "Loonie")
AUD/USD = "Aussie Dollar"
NZD/USD = "Kiwi"

Market Maker

A market maker provides liquidity for a particular financial instrument and stands ready to buy or sell that instrument by displaying a two-way price quote. In most cases, a market maker's commission is built into the spread.

Another Market Maker Definition

Forex ECN Broker

Electronic Communications Network. A Forex ECN brings together multiple market makers and traders to trade together between themselves, matching buyer and seller together for a small fee. It allows traders to act like market makers by being able to enter in their own bids and offers into the platform. A forex ECN displays all the available bids and offers from all market makers and traders on the platform, and matches your order to the best available price.

Other ECN Definitions:

Investor Dictionary

Investopedia

Counterparty

One of the participants in a transaction.

Sell Quote

The sell quote is displayed on the left and is the price at which you can sell the base currency. It is also referred to as the bid price. For example, if the EUR/USD quotes 1.3200/03, you can sell 1 Euro for US$1.3200.

Buy Quote

The buy quote is displayed on the right and is the price at which you can buy the base currency. It is also referred to as the ask or offer price. For example, if the EUR/USD quotes 1.3200/03, you can buy 1 Euro for US$1.3203.

Pip

The smallest price increment a currency can make. Also known as points. For example, 1 pip = 0.0001 for EUR/USD, or 0.01 for USD/JPY.

Pip Value

The value of a pip. Pip value can be fixed or variable. To calculate the pip value, divide 1 pip by the exchange rate, and multiply it by the lot size.

e.g. 1 pip EUR/USD = 0.0001 / exchange rate (1.2900) * 100,000 = 7.75 EUR. To convert back to USD, simply multiply it by the EUR/USD exchange rate. 7.75 * 1.2900 = $10 per pip.
1 pip USD/JPY = 0.01 / exchange rate (118.00) * 100,000 = $8.47 per pip.

Lot

The standard unit size of a transaction. Typically, one "standard" lot is equal to 100,000 units of the base currency, or 10,000 units if it's a "mini" lot, and even 1,000 units if it's a "micro" lot. Some dealers offer the ability to trade in any unit size, down to as little as 1 unit!

Spread

The difference between the sell quote and the buy quote or the bid and offer price. For example, if EUR/USD quotes read 1.3200/03, the spread is the difference between 1.3200 and 1.3203, or 3 pips. In order to break even on a trade, a position must move in the direction of the trade by an amount equal to the spread.

Standard Account

Trading with standard lot sizes

Mini Account

Trading with mini lot sizes

Margin

The deposit required to open or maintain a position. A 1% margin requirement allows you to control a $100,000 position with a $1,000 margin deposit.

Leverage

The extent to which you are using borrowed funds. To calculate leverage, divide your total open positions by your account equity to get the leverage ratio. e.g. If a trader has $1,000 in his account and opens a $100,000 position, he is using 100:1 leverage. If he opens a $200,000 position with $1,000 in his account, he is using 200:1 leverage.

Understanding leverage Part I
Understanding leverage Part II

Manual Execution

An order which is executed by dealer intervention.

Automatic Execution

The order is executed by computer software without human intervention or involvement.

Slippage

The difference between the order price and the executed price.

Long Position

A position in which the trader profits from an increase in price. Buy low, sell high.

Short Position

A position in which the trader profits from a decrease in price. Sell high, buy low.

Drawdown

The extent to which equity is lost in a trading account from a trade or series of trades, measured from peak to subsequent trough, most commonly in percentage terms.

Common Order Types

Market Order

An order to buy or sell at the current market price.

Limit Order

An order to buy or sell at a specified level.

Stop-Loss Order

An order to restrict losses at a specified level.

Limit Entry Order

An order to buy below the market or sell above the market at a specified level, believing that the price will reverse direction from that point.

Stop-Entry Order

An order to buy above the market or sell below the market at a specified level, believing that the price will continue in the same direction.

Trading Styles

Scalping

A style of trading that involves frequent trading seeking small gains over a very period of time. Trades can last from seconds to minutes.

Day Trading

A style of trading that involves multiple trades on an intra-day basis. Trades can last from minutes to hours.

Swing Trading

A style of trading that involves seeking to profit from short to medium term swings in trend. Trades can last from hours to days.

Position Trading

A style of trading that involves taking a longer term position that reflects a longer term outlook. Trades can last from weeks to months.

Discretionary Trading

A style of trading that involves the human decision making process for every trade.

Automated Trading

A style of trading that involves neither human decision making or involvement, whereby a pre-programmed trading strategy is automatically executed by computer software.

Example Transaction

Assume you have a trading account of $25,000 and you are trading with a 1% margin requirement. The current quote for EUR/USD is 1.3225/28 and you place a market order to buy 1 standard lot of 100,000 Euros at 1.3228, expecting the euro to strengthen against the dollar. At the same time you place a limit order at 1.3278, 50 pips above your order price.

The notional value of this transaction is $132,280 (100,000 units * $1.3228). Your required margin deposit is 1% of the total, which means you need $1322.80 account equity for this trade.

As you expected, the Euro strengthens against the dollar and your limit order is reached at 1.3278. The position is closed. Your total profit for this trade is $500 (each pip being worth $10).

Related Links

Introduction to Forex

Ask-an-Expert Forum

Free Position Size Calculator

Online Money Management Calculator

Forex Money Management Article

Courtesy : http://www.goforex.net