Currency Pairing

Reading the rate of two currencies can be confusing at first; however it is relatively easy if you remember two basic principles when you start your forex education:

The focus of the Forex market is the USD, and in the context of currency quotes this is deemed to be the “base currency”. The “Majors” are paired like these examples USD/CHF, USD/JPY and USD/CAD. As the USD and other base currencies are expressed as 1 the second currency in the pair is expressed in its value against the base currency. So reading a quote express thus:- USD/JPY 120.01 (this is just and example) means 1US Dollar = 120.01 Japanese Yen. If the USD is being used as the base unit and this quote goes up to for arguments sake: USD/JPY 124.2, the US dollar has strengthened against the Yen and will buy more Yen. In other words the JPY has weakened, in comparison to the first example we used.

There are only three exceptions to this and these are the GBP which is British Pound Sterling, the EUR or Euro and the AUD or Australian Dollar. In these instances the trader may see a quote like this GBP/USD 1.5273, in which case the British Pound Sterling is worth 1.5273 US dollars. At present, these are the three currency pairs where US currency is weaker and therefore when they are paired, they are the base currency and a rising quote indicates that the dollar is weaker. So it takes more dollars to purchase 1 GBP, AUD or Euro.

In a currency pair which does not include the USD they are referred to as being cross Currencies and a quote example could be EUR/JPY 132.95. This means that 1 Euro buys 132.95 Japanese Yen, and so on. As the Forex trader learns more they will see “Bid” and “offer” or two sided quotes. The bid is the price at which the base currency is sold in order to buy the counter currency and the offer (ask) is what the counter currency is sold for when the base currency is purchased. Perhaps now it is easier to understand why Forex trading education is so essential.

The PIP is definitely something all Forex trading education should teach about, it is the smallest denominator of a currency pair, and it is what the trader will always be looking for. An example being the quote of EUR/USD 1.3150 which moves up to 1.3155, signifying it has moved up five pips.

Forex trading education has to include an understanding of leverage for better profits and this is an easy concept to grasp. If the trader has a certain amount of money a Forex broker allows them to use this as security to trade with larger amounts. This is generally up to 400 times more than the trader has available or 400:1. There is a margin of either 50:1 or 100:1 and essentially this means if the trader has $1 000 the broker allows them to leverage with an amount of between $50 000 and $100 000.
This formula is important as every pip counts as a certain amount of dollars. Wit6h $10 000, one pip equals $1, so each pip of movement in a direction equals that amount in dollars. 5 pips = $5 and so on. For and amount of $100 000 a pip = $10 and so on. An example would be if the trader buys at 1.1555 and sells at 1.1655 this would be 100 pips, multiply this by 100 and the profit is 100 x $10 = $1 000.

The wonderful thing about foreign exchange trading is that money is made in two ways, and just as much profit can be made when a price goes down. Forex trading education teaches both these methods, so we commence with movement upwards as this is the most logical.

The concept of buying low and selling high is something that virtually everyone understands. In Forex trading this is called “going long”. So in a paired currency quote of EUR/USD at 1.2150 which was the buying price, selling at 1.2160 means a 10 pip gain, and this is a logical conclusion.

Reverse this process and hedge on the price of the currency going down to “go short” in other words, sell it first, then buy it back with the hope that it will go down again and make a profit.

This may appear to be strange but either way you look at it the concept is the same. The order in which these actions are executed is not important as long as the Forex is bought low and sold high. Just as long as this is maintained throughout all foreign exchange dealings, a profit will be made.

There is one major difference between trading on the stock exchange and trading Forex. This is broker commissions, they are extremely low or zero, so how do they make money? They make it on the spread. The spread is the price offered to a broker and the actual price of the Forex.

Typical currency pairs and their spreads can be found online from Forex feeds, and there will always be a difference in price between the offer, which is a “sell” order and the bid which is the “buy” order.

What this actually means to the foreign exchange trader is that they make some loss which is the brokers gain and this profit is the reason why the Forex broker is prepared to leverage traders so they can make profits. They also use the five finger rule “What’s – In – It – For – Me?” The traders’ loss is the brokers profit, so the Forex trader needs to learn as much as they can about spread in their education, setting targets to prevent loss is very important.

Whenever we see a film about the stock market the exciting words, Bull market and Bear market are used, this is also applicable to Forex trading. This terminology is consistently used and is used to describe the markets general mood. When the market is down and there are more sellers than buyers, this is a “Bear Market”. The opposite of this is the “Bull Market” which would mean there are more buyers than sellers. The trick is to be able to read the trends and be able to predict whether bulls or bears are going to happen next and gain the upper hand. Identifying the direction in which the price will go will help the trader decide whether they should trade long or short.

Forex trading education, if it is to be good has to include the ability to calculate profit and loss. Foreign exchange trades around the clock, six days a week and the value of the traders investment in this market, increase or diminish according to fluctuations either way in foreign currency. This commodity is sensitive to all kinds of market trends, including political and economic trends, even acts of God! It is important to be able to calculate profit and loss ahead of time in order to know when to get into or out of a trade as quickly as possible.

Understanding currency pairing, pips, leverage, short and long term gains, the spread and even bears and bulls as much as possible, helps with the calculation of profit and loss. Continuing education is also vital, so before trading any real money, open a practice trading account with a Forex broker and practice in real time while you learn.