Does Forex sound complex to you? First, the right order of the currency – why is it is that USD is placed in front for some cases, while it is placed at the back in some others? Second, there are 2 currencies that you will be trading.
Let’s dive in!
#1 Order Of Currency
It can be pretty confusing. When someone mentions EUR/USD (pronounced as Euro Dollar), EUR is in front of USD. However, USD is in front when USD/JPY (pronounced as Dollar Yen) is mentioned.
Here’s why!
The higher ranked currency will always be placed in front of the pair. Eg EUR/USD, AUD/USD, and USD/JPY.
AUD and NZD were worth more when they were first floated in the 1970s, hence they rank high up.
#2 Terms You Need To Know – Base And Quote
The first currency in any pair is known as “base currency” while the second currency in the pair is known as “quote currency”.
The value of the base currency is always “1”. This means if EUR/USD is trading at 1.1778, this means that 1 EUR = 1.1778 USD.
#3 Mechanics
Forex is always traded as a pair. For you to make money, you must know the different scenarios (caused be the movement in the base and quote currencies).
An example using EUR/USD to show the different scenarios are displayed in the diagram below.
If EUR increases in value while USD remains unchanged (from the 1st scenario), EUR/USD will rise. You will be able to get more USD with 1 Euro.
If you went Long on EUR/USD, you will profit only if EUR/USD increases. Looking at the last column of the diagram above, you will profit from the 1st and 4th scenarios.
However, if you sold EUR/USD short, you will make money only if EUR/USD drops. That’s shown in the 2nd and 3rd scenario.
Test Yourself
Pause scrolling to test your understanding.
Your friend tells you that USD/JPY is trading at 115.50. Which is the base currency? Which is the quote currency? How much is 1 USD worth in JPY?
What happens if the value of USD drops while JPY remains unchanged?
Ready to check your answers? Scroll on!
The base currency is USD while the quote currency is JPY.
1 USD is worth 115.50 JPY.
USD/JPY will drop. Refer to the diagram below.
#4 Bid & Ask
When you open any chart, you will see a quote. There are 2 components to every quote – Bid and Ask.
The bid price represents the maximum price that buyers are willing to pay for a security. It is also the price for short sellers to initiate their positions.
On the other hand, the ask price represents the minimum price that sellers are willing to receive for the security. It is also the price for traders looking to initiate a Long position.
Did you notice that there is a price difference between the bid and ask prices? That’s known as the spread. It is important to pay attention to the spread as it is a key indicator of the liquidity of that Forex pair. As a guide, the smaller the spread, the more liquid that Forex pair is.
Conclusion
Hooray! You know the proper order of currencies, the components that make up a quote, have a clear understanding on the mechanics of Forex, and lastly the bid, ask and spread. You are one step closer to successfully trading currencies!
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