So, you want to learn how to trade currency on the foreign exchange market? The process of trading currencies appears very straight-forward on the surface but, there is more to it than meets the eye.
The currency trading tutorial you are about to receive here will give you a basic idea of how things works. However, you must keep in mind that this tutorial is only scratching the surface. The Forex market is complex, fast-paced and requires serious further study if you wish to trade successfully.
Now that we have that disclaimer out of the way, let’s begin by looking at the fundamental unit involved in every trade: the ‘currency pair’.
What are currency pairs?
Currency pairs are units of 2 currencies involved in a foreign exchange trade. For example, if you want to sell U.S. dollars to buy Euros, you would look at the exchange rate quoted for the EUR/USD currency pair. Or, if you wanted to sell Euros to buy U.S. dollars, you would look at the exchange rate quoted for the USD/EUR currency pair.
You might thinking: “Aren’t they the same thing?” Well, they almost are, but you must look at the correct pair, in the correct order, based on the currency being purchased.
There are two reasons for doing this:
First, it is easier to calculate the results of your exchange in terms of how much of the base currency you can purchase with your ‘quote’ currency. Your base currency is the currency you intend to buy, and the quote currency is the currency you intend to sell in exchange for the base.
When quoting an exchange rate, your broker will list the base currency first in the pair, and the quote currency second.
This means that when you see a pair like EUR/USD, you are seeing the cost of 1 Euro in U.S. Dollars. An exchange rate quote of EUR/USD = 1.4436 means that 1 Euro costs $1.4436 in U.S. Dollars.
Likewise, the USD/EUR pair indicates the cost of 1 U.S. Dollar in terms of Euros. An exchange rate of USD/EUR = 0.6834 would mean that 1 U.S Dollar costs 0.6834 Euro.
The second reason for looking at the correct buy/sell ordered pair is that you’ll want to know the difference between the ‘bid price’ (exchange rate) and the ‘ask price’ (what the market makers want for the currency).
The difference between bid price and ask price make up what is known as ‘the spread’. Forex traders are subject to spreads when opening or closing trades in the buying position.
In other words, you are always subject to a spread when you buy, regardless of whether you are opening or closing the trade.
Open buy -> spread
Close sell -> no spread
Open sell -> no spread
Close buy -> spread
Let’s say that you want to buy the EUR/USD pair. The bid price is 1.4436. The ask price may be something like 1.4440. You must pay the spread of 0.0004 in order to do the trade.
Those are the basics of a currency trade, but there are other factors to take into consideration. In order to make a profit on currency exchanges, you must also know how
to calculate the cash value of exchange rate fluctuations in terms of ‘basis points’ – or, in Forex jargon – ‘pips value’.
This currency trading tutorial will not cover pips values, but it is a concept you should investigate further if you want to master the basics of trade on the foreign exchange.