How to Make Sense of Forex Trading Currency Prices

March 2, 2009 by  
Filed under Forex Trading

If you’re a traditional investor looking to spread your wings in the opportune world of Forex trading, or are new to the entire idea, the currency prices involved may seem quite confusing. Essentially, you will be purchasing one form of currency and selling another at the same time. New terms and methods are required to be successful in this form of trading.

Currency prices are always stated and trades performed in pairs. Unlike other trading, you are not simply buying shares in a specified company or sector. Your dollars are traded for euros, yen, or other types of foreign currency, hedging your bets that the value of it will rise in the short term.

The major forms of foreign currency involved include the U.S. dollar, the euro, the Australian dollar, the British pound, the Canadian dollar, Japanese yen, and Swiss franc. Prices are typically listed like this:

Euro/dollar (USD) Bid: 1.1901 Ask: 1.1903

These will also be listed with change, change %, high, low and the time of the quote. When looking at this price, the first form of currency is the ‘base’, which is the euro in this example. The dollar is referred to as the ‘quote currency’.

The ‘bid’ is the actual cost of the base currency expressed in the quote currency’s units, so in this example, one euro is purchased for $1.1901 dollars. The ‘ask’ is what a broker will sell the currency to you for, so in reality one euro will cost you $1.1903, and the broker’s cost is $1.1901. The difference is the broker’s ‘spread’, or profit; this is how Forex brokers make their money instead of charging a commission.

However, the ‘bid’ price is what you will receive for your euro when you sell it. So, the euro you paid $1.1903 for can be sold immediately at a loss for $1.1901. When the bid price changes from 1.1901 to 1.1902, this is referred to as a single ‘pip’. This reflects the change in the bid, and thus reflects your profit or loss.

Unless your broker offers you a ‘mini’ account, these currency pairs are sold in lots of 100,000, which requires a significant up-front investment on your part. However, Forex brokers will typically ‘finance’ 99% of your trade, so that you can execute your buy order for only 1% of the total cost. When it comes time to sell, the entire profit, if any, is yours to keep – this is how profits can become exponential in a short amount of time.

Conversely, if the bid drops 10 or 20 pips, you may end up owing your broker his share of the loss, if this totals more than your 1% investment.

The good news, for traditional investors, is that many of the same technical indicators apply when trading currency. Several tools including moving averages, Bollinger bands and pivot points can easily indicate the likely direction of the Forex market, the currency pair you’re watching, and be immediately recognized by you.