Here we will look at some Forex trading basics and cover how currencies are actually traded against each other. If you have read our Introduction to Forex then you know that FX is all about buying and selling different currencies in the belief that their values are about to change. If for example, you think that the British Pound (GBP) is about to grow stronger then you will probably be looking to buy some pounds. When making your purchase you obviously need to give something in return which is of equal value to the pounds you will receive. In Forex trading, this is going to be another currency such as US Dollars (USD) or Swiss Francs (CHF). All currencies are therefore traded in pairs.
The Major Currency Pairs
In order to understand Forex trading basics you will need to become familiar with the most commonly traded currency pairs. These are known as the ‘majors’ and are displayed in the following table, along with the names traders will tend to use when referring to them. Note that all of the majors feature the US Dollar as one of the currencies in the pair.
| Major Currency Pair | Name |
|
EUR/USD |
‘Euro Dollar’ or ‘EU’ |
|
GBP/USD |
‘Pound Dollar’ or ‘GU’ |
|
USD/JPY |
‘Dollar Yen’ or ‘UJ’ |
|
USD/CHF |
‘Dollar Swissy’ |
|
USD/CAD |
‘Dollar Loonie’ |
|
AUD/USD |
‘Aussie Dollar’ |
|
NZD/USD |
‘Kiwi Dollar’ |
Cross Pairs
There are several currency pairs which are traded frequently but do not feature the US Dollar (USD). These are referred to as ‘cross pairs’ and still make up quite a bit of the daily trading volume in the Forex market. The most common crosses will include the Euro (EUR), British Pound (GBP) or Japanese Yen (JPY). Here are some popular cross pairs.
|
Cross Pair |
Name |
|
EUR/GBP |
‘Euro Pound’ or ‘EG’ |
|
EUR/CHF |
‘Euro Swissy’ |
|
EUR/JPY |
‘Euro Yen’ or ‘EJ’ |
|
GBP/JPY |
‘Pound Yen’ or ‘GJ’ |
|
GBP/CHF |
‘Pound Swissy’ |
|
AUD/JPY |
‘Aussie Yen’ or ‘AJ’ |
There are obviously a lot more pairs available to trade than the ones we have listed. We would however highly recommend sticking to currency trading basics and focusing on the most popular pairs when you are a new trader. The main reasons for this are high liquidity low trading costs. Also, it is wise to trade only one pair when you are first starting out so that you are able to get a good feel for how it moves, as each pair will behave differently. We have highlighted over a dozen pairs, giving you plenty to choose from.
Reading a Quote
Continuing with this foreign exchange basics tutorial we will now look at how to read quotes from your FX broker. This is extremely important as you need to be sure exactly what you are buying or selling before you put any money at risk. Initially, the constantly changing numbers in the area where your broker displays quotes can seem a bit confusing, even daunting. When you get to know what each figure represents it is actually all pretty simple though.
An FX quote will consist of two three letter symbols separated by a slash (/). These letters represent the pair of currencies which will be traded against each other. There will also be a price displayed, do not worry about the prices for now, we will come to those later on in this currency trading basics tutorial. For Example, If you want to trade the Euro Dollar pair, the symbols will appear as . . .
EUR/USD = 1.40322
Whichever currency appears first on the left is referred to as the Base currency. The currency on the right is called the Quote currency or Counter currency. So in our above example, the Euro is the base and the US Dollar is the quote/counter. The exchange rate listed (1.40322) tells you what amount of the quote currency will be needed to buy 1 unit of the base currency. So here, it will cost 1.40322 US Dollars to by 1 Euro. The reverse is true if you were to sell the base currency. You would receive 1.40322 US Dollars for the every 1 Euro you sell.
Buy/Sell and Long/Short
To get your head around Forex trading basics you will need to understand some of the language used by traders when they are talking about buying or selling a pair. Firstly, it is important to note that the words ‘long’ and ‘short’ are used interchangeably with ‘buy’ and ‘sell’
Buy = Long
Sell = Short
So, if you are buying a currency then you could describe this as ‘buying’, ‘going long’ or ‘taking a long position’ – it all means the same thing. Also if someone says they are currently ‘long the Euro Dollar’ then they will have recently bought that pair. Selling can be referred to as ‘selling’, ‘going short’ ‘taking a short position’ or just simply ‘shorting’. Being ‘short Euro Dollar’ means you have recently opened a sell trade.
Above, we mentioned buying or selling a pair. Of course what you are actually doing when placing a trade is swapping one currency for another. The terms buy, sell, long and short refer to what you are doing with the base currency. So, if you are buying EUR/USD then what you are doing is buying Euros and selling US Dollars. If you are ‘shorting’ USD/CHF then you are still selling US dollars, but this time you are buying Swiss Francs with them. Notice how knowing the difference between the base and quote currencies is very important as the language used to describe which type of trade you are making will always refer to the base. Buying or ‘going long’ means buying the base, and the opposite is true for selling or ‘shorting’, this would mean selling the base.
The most important thing to remember is that in every trade you are buying one currency and selling another. Buy, sell, long and short describe what you are doing with the base currency, which is the one appearing on the left.
The Bid and Ask
The next thing you will need to know if you want to learn Forex basics is the difference between two prices which are called the bid and ask. Here is how the two prices will appear when you are looking at a quote.
EUR / USD
1.40328 / 1.40349
The vast majority of the time you can expect the bid to be a lower figure than the ask. The bid represents the price you will get when selling or shorting the base currency and receiving the quote currency in return. It is the rate which your broker will pay you and should be the best that is currently available.
If you are looking to buy or go long then you will be paying the ask price. This represents the lowest price your broker is currently willing to offer you when making your purchase, you will be paying for the base currency you are purchasing using the quote currency. This price can also be referred to as the offer price.
In our EUR/USD example the bid price is 1.40328 and the offer is 1.40349. So you can basically buy Euros at 1.40349 and sell them at 1.40328. The more cunning among you will notice that you are always losing out a little to your broker when taking trades at these prices. The difference between the bid and ask price is known as the spread and is basically the cost of trading, and how your broker turns a profit. The spread amount will usually be at least two pips in size for the most popular pairs, and even more for those with less liquidity. Check this guide to read about Forex pips in more detail.
Ok so that covers the basics of Forex market trading as far as currency pairs and quote reading are concerned. The terminology can be a little tricky to begin with, so you may need to read over this article more than once. Once it starts to sink in then you will realise that the above principles are actually quite simple. Just keep at it and feel free to ask any questions about currency trading basics via to the comments section below the post.
Next Steps
If you have not already done so, refer to our 2 part guide on learning to trade FX which will talk you through the steps you will need to take in order to get your trading career on the right track. Part 1 is called learn Forex trading and covers some currency trading basics, such as the reasons you may want to trade FX. Part 2 of the guide, learn to trade Forex discusses the different aspects of trading you will need to master and shows you where to go next. If you have read these guides already then check out our Forex for beginners post which introduces pips, lots and Forex leverage – following on nicely from what you have just learned.
