The business of the forex market is the buying and selling of currencies for a profit, in other words, you exchange one currency for another hoping that the currency you bought will increase in value compared to the one sold. Actually, successful forex traders do more than hope, they employ techniques and measures that inform their trading decisions.
Taking note of exchange rates at all times is very important, as exchange rates are major decisive factors in trading profitably. In fact, the exchange rate determines whether you make a profit or loss.
Exchange rate is the rate at which one currency can be exchanged for another, usually expressed as the value of the one in terms of the other.
Let’s assume that you have $500 on your trading account and want to trade EUR for USD. Its exchange rate is 1.25, which means that for 1 euro you get 1.25 US dollars.
Then, you make a forecast – for example, you believe that the Euro will rise versus the US Dollar.
Next, you buy 400 euros for your $500 and wait for the exchange rate to change.
Let’s imagine the exchange rate rose from 1.25 to 1.35 – Now, you can exchange your 400 euros back to 540 dollars, thereby making a profit of $40.
UNDERSTANDING CURRENCY PAIRS:
In every currency pair, there are usually two currencies quoted and that’s because forex transactions demand that you buy a currency and sell another simultaneously. It is, however, important to understand how currencies are quoted.
The first listed currency before the slash (“/”) is known as the base currency, while the second one after the slash is called the counter or quote currency
When buying, the exchange rate tells you how much you have to pay in units of the quote currency to buy ONE unit of the base currency. In the example above, you have to pay 1.51258 U.S. dollars to buy 1 British pound.
When selling, the exchange rate tells you how many units of the quote currency you get for selling ONE unit of the base currency.
In the example above, you will receive 1.51258 U.S. dollars when you sell 1 British pound.
MEANING OF LONG/SHORT
The concept of going ‘long’ or going ‘short’ is a popular one in the forex market, it is pertinent that every new trader understands these concepts.
Basically, going long means that you have a positive expectation on the future value of a currency and going short means that you have a negative outlook on a currency.
Here are the most notable differences between long and short positions:
THE BID ASK AND SPREAD
Don’t get it twisted, a bid price is not the price you’ll bid when you want to buy a currency pair. Both terms could be confusing especially if you try to understand it outside the Forex view.
These two terms can be best understood when viewed from the perspective of the forex broker. The bid is the price at which your broker is willing to buy the base currency in exchange for the quote currency. This means the bid is the best available price at which you (the trader) will sell to the market. If you want to sell something, the broker will buy it from you at the bid price.
The ask is the price at which your broker will sell the base currency in exchange for the quote currency. This means the ask price is the best available price at which you will buy from the market. Another word for ask is the offer price.
When you’re buying, you’ll pay what the broker’s asking for the currency; when you’re selling, you’ll need to accept what the broker’s bidding.
The difference between the “bid” and the “ask” is called the spread. The spread is simply the broker’s commission on the trade.