Interpretation of Forex Exchange Rates
In this lesson we will give a practical explanation of online forex trading.
As mentioned in the previous lesson, currencies are traded in pairs. Examples of currency pairs: EUR / USD, GBP / USD, USD / JPY (below a state with explanation abbreviations). That means you always speculate on the rise of one currency against another currency. Opening a forex position is nothing but the buying of one currency and simultaneously selling a few of the other. You earn the the increase in value of the purchased currency, relative to the currency sold.
A currency pair in Forex is shown by the two abbreviations for the currencies concerned with a slash between them. Each currency has its own three-letter abbreviation. For the main currencies are the following:
- USD = U.S. Dollar
- CHF = Swiss Franc
- EUR = Euro
- CAD = Canadian Dollar
- JPY = Japanese Yen
- AUD = Australian Dollar
- GBP = British Pound
- NZD = New Zealand Dollar
As you may suspect already, the currency pair GBP / USD is a combination of British Pound – U.S. Dollar. The first abbreviation (GBP here) is called the “base currency”, which is the currency you speculate on. So if you buy GBP / USD, you expect an increase of the British Pound. The second abbreviation (here USD) is called the ‘quote currency’. The expected increase in the British Pound is in this case at the expense of the U.S. Dollar.
Incidentally, you will encounter new insider-terms. The world of Forex has its own jargon, with terms like pip, spread, bid, ask, long, short etc … do not be deterred by these terms because youâ€™ll learn this on-the-fly. It may be disencouraging, but on the other hand it will give you a nice oppertunity to brag about your Forex success on parties.
Forex Exchange Rates and spread
Spread is the difference between bid and ask. This is what you pay to the broker for the open position. Unlike other markets (like the stock and options market) , the broker calculates no cost to you, except the spread. This gives Forex trading a low entry.
In general, the spread is very small, often three hundredths of a cent. In the forex world one would say: the spread is three ‘pips’. A pip is the fourth decimal of a currency price notation. (Only for the Japanese Yen a pip is the second decimal place, because Yens are approximately a hundred times less valuable than most major currencies.)
Long / Short
There are two different types of positions you can open, a long position and a short position. For a long position you will expect that the price of the base currency will rise in comparison to the quote currency. If you have a long position on the USD / CAD takes, that means you are buying U.S. Dollars and simultaneously sell Canadian Dollars. For a short position you expect the price of the quote currency to rise in comparison to the base currency. In other words, you buy Canadian Dollars and simultaneously sell U.S. Dollars; long / short are opposites!
The idea of a short position is for many new traders difficult to understand. You are actually selling something you donâ€™t have. This is possible because you donâ€™t have to deliver the currency immediately. You do that when you close the position.
It’s like selling someone a bag of apples, while you donâ€™t really have any apples. You know however, that you will have to deliver the apples when some time has passed. You speculate that in the meantime the price of apples will drop, so at the time of delivery the apples are cheaper than what you asked for it. It will be cheaper for you to deliver the apples.