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Making Sense of Forex Quotes and Pips

Forex quotes are always listed in pairs, these quotes reflect the exchange rates of the currencies. These pairs look like this: GBP/USD = 1.9714. The currency listed first is known as the base currency (being the base of the trade), the second is called the counter, or quote currency.

All well and good, but what do these numbers mean? The value of the pair is a ratio of one unit of the base currency to it's equivalent in the quote currency. Supposing that you expect the value of the base to rise against the quote, buy the base currency and sell the quote currency, and vice versa. As an illustration, say that the value of the Euro (EUR) is expected to rise against that of the US Dollar (USD). In this case, buying Euros and selling US Dollars at the same time is what you would normally do. This is called going long.

Further, take the Forex quote CHF/USD = 0.8944 as an example. Say that the Swiss Franc (CHF) is expected to fall as compared to the US Dollar (USD). You would sell US Dollars and buy Swiss Francs - this would be going short.

Now, in an actual Forex trading situation, the exchange quotes will be listed at two slightly differing prices, for instance: EUR/USD = 1.7420/1.7425. The left quote is the Bid price, the right is the Asking price. The difference between these is call a Bid/Ask spread, or just Spread for short. The Bid price is the price you can sell your currency for, while the Ask price is the price at which you can purchase the currency.

This spread means that if you were to buy a great deal of currency, then sell it before there had been any change in the relative values of the two currencies, you would lose money on the trade, but the dealer would make money from the trade. A Forex dealer makes their money from the Ask/Bid Spread. They are in a good position, as they stand to make money whether or not you do well with your trade.

Forex quotes are typically quoted to four decimal places - for example:

USD/EUR = 0.6793
EUR/GBP = 0.7468
GBP/CHF = 2.2041
CHF/AUD = 1.0095

The exception to this rule, at least among the major currencies, is the Japanese Yen (JPY) . If the Yen is being quoted, then the Forex quotes are just to two decimal places, as in these examples:

USD/JPY = 109.32
EUR/JPY = 160.95

This is due to the value of the Japanese Yen being only about one hundredth of the value of one U.S. dollar.

A change of 1 in the last decimal place in a quote is named a Pip. this is the smallest amount by which the relative values of two currencies will change. Normally, a Forex brokers commission (the Ask/Bid Spread) will be somewhere between 2 and 5 Pips.

A movement of 20 to 50 Pips is a typical shift in the value of a quoted pair on any given day of Forex trading. The market can sometimes experience greater volatility though, with much larger movements being seen. In November 2007, there were some bigger shifts in the relative values of the US Dollar (USD) and the UK Pound (GBP), when the change in relative value of the two currencies was as much as 200 Pips on some days.

Usually, the daily changes in the Forex market are very small - so trading with very large amounts of money is the way to go if you are to make a sizable profit.

Let's say that the Euro (EUR) is expected to rise against the U.S. Dollar (USD). Based on this, you buy 100 Euros at a quote of EUR/USD = 1.4720/1.4725. A hundred Euros would cost you $147.25. If the Euro rises fifty Pips against the dollar the quote is now EUR/USD = 1.4770/1.4775.

Then say you sell your hundred Euros and buy U.S. Dollars. Your Euros would then fetch $147.70, or a profit of only $.045. Not much - even had you purchased a thousand Euros, you would still only have $4.50 to show for a day's trading. This is why Forex trading is generally done with much larger amounts of money.

Related to: forex , forex trading , currency trading , forex system , forex software Seed Newsvine

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