Why Are Currencies Traded as Pairs?
When you buy or sell a currency through a broker or dealer you are trading in currency pairs. Whilst this may sound like confusing to some, it is very simple once explained. “Pairs” are made up of two currencies. For example; you have the EURUSD which is the EURO and US Dollar.
When you buy the EURUSD you are buying the Euro and selling US dollars.
If you are buying you think that the EUR is strong compared to the US dollar. If you were to enter a trade on the EURUSD thinking that the EUR was weak compared to the US dollar, you would short the EURUSD.
This is how all Forex currency pairs work. You are trading on the assumption one side of the pair is stronger or weaker than the other side of the pair.
Some of the major pairs are listed below:
How to Read a Forex Quote
If the EUR/USD exchange rate is trading at 1.1500, this means that it will cost you 1.1500 US Dollars in order to purchase one unit of Euros. The first listed currency (in our case is EUR) represent one unit of that currency while the Forex exchange rate (in our case 1.1500) represent how much of the second currency (in our case USD) is needed to purchase that one unit of the first listed currency (in our case EUR).
In our example, the EUR/USD exchange rate it tells us how much it cost to buy one Euro using US Dollars. If we want to reverse the process and find out how much it cost to buy one US Dollar using Euros we need to apply the following formula:
If we apply the formula to our base case 1 / 1.1500 = 0.8695, it means that it will cost us 0.8696 Euros to buy one unit of US Dollars. This new price would also represent the exchange rate of the USD/EUR currency pair; where we can see that the currencies have switched their positions.
The Base Currency and the Quote Currency
The first currency listed in any currency pair is called the Base Currency (in our case it’s the EUR) while the second currency to the right of the slash is called the Quote or the Counter Currency (in our case it’s the USD)
When the buying and selling in the Forex market occur the Base Currency is always the currency of reference. In our base case if we’re buying EUR/USD this implies that we’re buying the Base Currency (in our case, it’s the EUR) while if we’re selling EUR/USD this imply that imply that we’re selling the same Base Currency.
Since all currencies are quoted in pairs when we’re buying EUR/USD we’re simultaneously buying the Base Currency (in our case, it’s the EUR) and at the same time selling the Quote Currency (in our case it’s the USD), simply put it we “buy EUR, sell USD.”
Understanding the Forex Jargon
The Forex market has a distinctive language and in the professional world of Forex trading is a common practice to use a specific jargon and refers to each currency pair by its nickname. The most common currencies and the most traded currencies have a nickname designed to just simplify the way we address and interact. Here are just a few of these common nicknames;
- EUR / USD – It’s also known as Fiber;
- GBP / USD – It’s also known as Cable;
- AUD / USD – It’s also known as Aussie;
- NZD / USD – It’s also known as Kiwi;
- USD / CAD – It’s also known as Loonie;
- USD / JPY – It’s also known as Yen;
- USD / CHF – It’s also known as Swissy;
Long or Short
When trading Forex you have two options. You can either enter a “long “position which means you are buying, or a “short” position which is selling. The easiest way to remember it is like this;
- Long – Buy
- Short – Sell
A lot of people come straight from trading stocks and have only ever bought a stock and tried to make money by selling once that stock has gone onto a higher price. In Forex it is just as easy to both buy and sell and to make money from either way. The same amount of profit can be made as if price moves lower as if it had moved higher, so looking for high probability “short” trades is just as good as looking for long trades. In many cases price will move a lot faster when it moves lower than what it does higher.
This gives traders a lot more options. Instead of watching a market trending down and not being able to make money from this, Forex traders can sell high and buy back low and make money the same as if they had bought low and sold high.
Types of Forex Orders
In order to be able to make a transaction in the Forex market and enter or exit from a position, you have to use one of the few available order types. There are a few different order types available for entering into a position that the majority of the brokers will provide. Without further ado, these are the most common order types available to enter a trade:
- Market Order is a customer order for immediate execution at the best available price for immediate execution. Most of the times when you place a market order it will be executed at the current market price, however, sometimes during news events they will be executed at the best available price due to the high volatility and you may encounter slippage;
- Buy Stop Order which is an entry buy order to get in the market when the price is above the current market price. Buy stops are a popular orders to use when trying to buy above resistance levels;
- Buy Limit Order is an entry buy order when the current market price is above the price one would like to buy;
- Sell Stop Order is an entry sell order to get in the market when the price is below the current market price. Sell stops are popular orders to use when trying to sell below support levels;
- Sell Limit Order is an entry sell order when the current market price is below the price you would like to sell;
- Stop Loss Order is a protective order designed to limit your losses if price moves against you;
- Take Profit Order is an order designed to lock in profits at the desired market price;
Bid and Ask
When looking to take a trade on a Forex pair the trader will be quoted two prices. These prices are known as the Bid and Ask. A picture of this is below.
The bid price is the current price you can sell this pair. You can see the big price on your left on your order ticket. This is also the same price that the broker is offering you to sell this pair. The ask price is the current price on offer to buy this pair from the market. This is also the price your broker is offering you to sell. The difference in between the two price is the spread as discussed below.
You will notice that there is a margin in between the bid and ask price. This gap in price is known as the spread. On every round trade you make you will pay the spread. The spread is a how the broker makes money from their traders making trades.
Brokers take their live prices from a live data feed which is normally a group of banks linked together. The broker then takes the live bank price and adds the spread to the price. From there they quote you the price you see on your trading platform.
Note: Quite often when opening an account a broker will offer traders the choice of two accounts. The first account will be an account with very tight spreads.
Traders need to be aware of this account because whilst this account may offer tighter spreads, this account will often then charge commissions on every round trade placed on top of the spreads.
The other account is often then the standard account that offers slightly larger spreads, but with no commissions. This is something that each trader’s needs to work out for themselves and which account they want to choose.
More on how brokers operate can be found in later sections including a very good broker that recommended for price action traders.