The Basics of Forex Trading

Posted by forex on August 18th, 2010

?Forex? is a short form of Foreign Exchange. Foreign exchange trading means trade between currencies of two different countries with each other, buyer is purchasing one currency and in exchange provides another currency to the seller. Relative value of a particular currency is decided by the forex market. Major currencies traded in the forex market are US Dollars USD ($), Euro EUR (?), Great Britain Pound GBP (?), Japanese Yen JPY (? ), Swiss franc CHF(Fr), Australian Dollars AUD($), Canadian Dollar CAD ($).

Main purpose of the foreign exchange market is to help business houses to do international trade, by converting currency from one to another. For example, a US company wants to buy raw material from Briton and it has to pay money in Pound Sterling.

Forex market has a huge trading volume and it is the biggest financial market in terms of liquidity.

Let?s try to understand some basic terms of Forex market.

Currency Pair

Forex trading is always done in a currency pair. Quantity of one currency is bought in exchange of another currency. Currency pair indicates which currency is bought in exchange of the currency you sold. Four major currency pair traded on the market includes EUR/USD, GBP/USD, USD/CHF and USD/JPY.

Let?s take an example: 1 EUR = 1.5 USD

It means you will pay 1.500 USD to buy 1 Euro. The base currency is the first currency in the pair, and its unit is always 1. Second currency in the pair is equal to value you will take to buy one unit of the first currency.

PIP

PIP is the short form for ?Percentage in Point?. PIP is a small unit in price change. Say for the example, you are dealing in EUR/USD pair and if you bought currency pair at 1.500 and sold it at 1.600, you have made 100 pips. To make an explanation simpler, you bought 1 Euro for 1.500 USD, and then you sold it for 1.600 USD. So you have made profit of 100 pips. More pips you gain more profit you make.

BID/ASK Price

It is very difficult to buy or sell currency at the current exchange rate. Look at the following.

EUR/USD = 1.500 / 1.510

This statement is very confusing, Euro is a base currency here, USD Bid Price is 1.500 and Ask Price is 1.510. Bid price is referred to as buy price and Ask Price is the sell price. This is bit confusing, because it is referring to market buy and sell price and not yours.

Bid Price is the price, at which market is buying the currency. In the above example, bid price is 1.500 USD, so for each 1 unit of Euro you sell, you will get 1.500 USD, so it is your sell price, but it is the buy price in the market.

Ask Price is the price at which market willing to sell. In fact it is your buy price. In the above example, for buying 1 unit of Euro, you have to pay 1.510 USD. 

Sometimes BID / ASK Price are written as below

EUR/USD = 1.500 / 10.

It has the same meaning as

EUR/USD = 1.500 / 1.5010, which is explained above.

SPREAD

Spread means difference between the Ask Price and the bid price. Spread in the above example is 10 pips. In the above example if you want to buy 1 Euro, you are paying Ask Price 1.5010 USD, and you want to sell it immediately, you will get Bid Price 1.500 USD, means you will lose 10 pips. So if you don?t want to make loss, you will have to wait till bid price becomes 1.5010.

A low spread is good for you to make more profit, because every time you trade, it takes out that much amount from your profit.

Now you know basics of forex trading.