Forex glossary of terms
Reading forex quotes is one of the most confusing matter for forex newbies. However, it is simpler than most people thought once you understand the basics behind the quotes.
It is common to see a quote like this, known as the currency pair :
USD/EUR = 1.1252, but what does it mean?
When you come across a quote like this, the currency on the left is called the base currency, and it is used as a benchmark for exchange. This is simple because foreign exchange occur between 2 different currencies. For this purpose, the value of the base currency is always 1. The currency on the right is called the counter or quote currency. This quote serves to tell us how much quote currency we can buy with one base currency. So, in this case, the quote tells us that for 1 USD, 1.1252 Euro can be bought. Quotes are usually quoted with a four decimal point number, as a slight move in forex means a significant profit or loss to investors.
To make things simpler for a trader, one can opt to have a quote using one's native currency as the base currency. For example, a Japanese looking to buy USD will have a easier understanding of his purchasing rate using the JPY/USD quote. This is known as a direct quote. Since most currencies are traded against the USD, the USD is commonly used as the base currency. In the case of the Japanese, the normal quote he will get is a USD/JPY quote, with the USD acting as a base currency. This is known as an indirect quote.
What about currencies which are not traded against the USD? Those currency pairs that does not involve the USD is usually not very actively traded, known as cross currencies. Examples of cross currencies are JPY/GBP, EUR/CAD and so on. According to author Jamaine Burrell of 'The Complete Guide to Currency Trading & Investing', "cross currency pairs effectively equate to two separate currency pairs." This is because, brokerage still use USD as the benchmark in selling and buying. For example, a GBP/JPY quote consist of buying a GBP/USD and selling a JPY/USD currency pair. Burrell also stressed that because of this. "cross currency pairs are likely to carry higher transaction costs than currency pairs that include the USD or Euro."
Often, cross currency pairs can involve some more lowly traded currencies. These type of currency pairs are known as exotic currency pair. While its name may seem fancy, this basically means that its liquidity is low and more risky due to its slow trading activities.
Sometimes, you may also come across quotes like this:
USD/CAD = 1.1203/07
This type of quote can work both ways. As you may already know by now, one can enter the market by short selling a currency (ask) or buy a currency (bid). In the example above, the USD value is always 1 since it is the base value. The quote tell us that we can short (ask) the USD by selling it at 1.1207 CAD or we can buy (bid) it at 1.1203 CAD. Note that the ask price is always higher than the bid price.
With a bit of practice, reading forex quotes become a second nature to traders. This is the first step to gain hands-on experience in forex trading.
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