Beginners in the currency trading market often get confused when it comes to the currency quotes. In this session, we’ll take you through currency quotations and how these quotations work in the currency trading market.
How to Read a Quote?
As you are aware, the quote for a currency is always done with respect to another currency. In simple terms, a currency quote reflects the value of a particular currency with respect to another currency. So, when you are trying to figure out the exchange rate between US dollar and Japanese yen, the quote would look something like this:
USD/JPY = 116.50
This is called a currency pair. The currency on the left side is called the base currency whereas the currency on the right side of the quote is known as counter currency or quote currency. In this case, the base currency is USD and the quoted currency is Japanese yen.
This quote shows the amount of Japanese yen you will get in exchange for one unit of base currency (USD). In simple terms, it means US$1 = 116.50 JPY. If you want to exchange USD for Japanese yen, you will get 116.5 Japanese yen for one US dollar. The forex quote given above uses the currency abbreviations for these particular currencies.
Difference between Direct and Indirect Quote
Currencies are quoted directly as well as indirectly. In fact, this is the biggest source of confusion for beginners in the foreign currency trading market. Here is a brief guide on the difference between direct and indirect currency quote.
In simple terms, a direct currency quote is defined as a currency pair where the quoted currency or counter currency is the domestic currency. On the other hand, the base currency is the domestic currency in case of an indirect quote. So, if you want an indirect quote for Canadian dollar versus US dollar, it will be quoted as CAD/USD whereas the direct currency quote for this currency pair would be USD/CAD.
Another way to remember this concept is to keep in mind that in case of direct quote, the domestic currency varies with regards to the foreign currency or base currency, and the base is fixed at one unit. The opposite happens in case of indirect quote where the domestic currency remains fixed at one unit whereas the foreign currency varies with respect to the domestic currency.
For instance, a direct quote for USD versus Canadian dollar where Canadian dollar is the domestic currency will be quoted as 1.15 USD/CAD. It means that one will get C$1.15 for US$1. If this currency pair is quoted indirectly, the rate would be the inverse which calculated to 0.87 CAD/USD (derived as 1/1.15). This rate means that you will get USD $0.87 for each C$1.
Most of the currencies in the forex spot market are traded against the US dollar. This is the reason that US dollar is quoted as the base currency in most of the currency pairs traded in the forex market. In such cases, it is known as a direct quote. This quote will also apply to the above mentioned USD/JPY pair where one US dollars will buy 116.5 Japanese yen.
While there are many pairs where US dollar is the base currency, there are also some pairs where the other currency is quoted as the base currency. For instance, currencies such as Australian dollar, New Zealand dollar and British pound (aka Queen’s currencies due to their historical association with Britain) are quoted as the base currency against USD.
The euro is also quoted in a similar manner. In such cases, the exchange rate is referred to as indirect quote where USD is the quoted or counter currency. This is the reason that EUR/USD quote is given as 1.35 which means that one can get 1.35 USD for one euro.
In most of the cases, the currency exchange rates are quoted to 4 digits after the decimal place. Japanese yen is an exception as it is quoted out to only 2 decimal places.
Cross currency is the term used to define a currency quote where the US dollar is one of the currencies in the pair. Some of the common examples include EUR/JPY, EUR/CHF and EUR/GBP. The availability of these currency pairs expands the possibilities for traders in the forex market. However, beginners should also note that these cross currencies do not have as much liquidity as is the case with currency pairs that include USD. Currency pairs that include US dollar are also known as the majors.
Bid and Ask
When you are trading in financial markets, you will be offered a bid price and an ask price in most of the asset classes. In currency trading, you will be offered a bid price which is the buying price and an ask price which is the selling price. These prices are related to the base currency. When you go long or buy a currency pair, the ask price of the currency quote is the amount of counter currency you have to pay to get a unit of base currency. In other words, it refers to the purchase price of one unit of base currency with respect to the quoted currency.
While selling a currency pair a.k.a. going short, bid price is used to reflect the amount of quoted currency a trader will get when he or she sells one unit of base currency. In other words, the amount of money a trader will pay for the quoted currency in terms of the base currency.
Let’s look at an example:
USD/CAD = 1.2300/06
Bid = 1.2300
Ask = 1.2306
This is how a typical quote looks like. It includes the bid as well as ask price. Bid price is the quote before the slash whereas the last two digits after the slash refer to the ask price. Typically, only the last two digits are quoted instead of the full price. Keep in mind that bid price is always going to be lower than the ask price.
If you want to go long on this currency pair, it means that you want to buy the base currency. Therefore, you need to look at the ask price to figure out how much Canadian dollars you will need to pay for one US dollar. As per the above quote, you will need to pay C$1.2306 for buying one US dollar.
When it comes to shorting or selling this currency pair, you need to look at the bid price. The bid price tells you that you will get C$1.2300 for selling one US dollar base currency.
Keep in mind that the transaction currency is the base currency or the currency that is put first in the quote. You can buy as well as sell the base currency. For determining the price, you need to refer to the spot exchange rate of the corresponding currency pair for buying or selling the base currency.
Pips and Spreads
Spread refers to the difference between bid and ask price. For instance, if you are quoted EUR/USD at 1.2600/04, it means that the spread in this case is 4 pips or points (0.0004). While these numbers may seem insignificant, you need to keep in mind that even a small change in these numbers can result in thousands of dollars of profit or loss due to high leverage in the forex currency trading. This is the reason that forex market attracts so many speculators as there is huge potential for making money even with such small price movements.
As you may have noticed, pip refers to the smallest amount of price movement in a currency quote. One pip is 0.0001 in case of Swiss Franc, British Pound, Euro and US dollar but Japanese yen is an exception as it is quoted to 2 decimal points. In case of Japanese yen, one pip is 0.01 whereas the pip would be 0.0001 CHF in case of USD/CHF quote. Most of the currencies in the forex market usually trade within a range of 100 to 150 pips on a day.
Forwards and Futures in Currency Trading
One of the major technical differences in the spot and forward or futures markets in the forex trading is the manner in which currencies are quoted.
In case of futures or forwards markets, the foreign currency is always fixed at one unit and US dollar varies in value. In simple terms, the prices reflect the units of USD required to buy one unit of foreign currency.
Keep in mind that spot market works in a different manner. In some currency pairs, US dollar is the base currency whereas it is the quoted currency in other pairs. Therefore, the spot market quotes and forward or futures quotes do not always move parallel to one another.
For instance, the British pound is the base currency against the US dollar in the spot market. It also works in a similar manner in the forwards and futures markets. So, when US dollar rises against the British pound on the spot market, it will also gain in the forwards and futures markets.
However, this is not true in case of all currencies. For instance, Japanese yen and US dollars are quoted in opposite manner in the spot market and futures or forwards markets.
Let’s take an example. Assume that the current quote for USD/JPY in the spot market is 119 which mean that one can buy 119 Japanese yen for one US dollar. However, it will be quoted in the opposite manner (1/119 or 0.0084) in the futures market. It means that one can buy US$0.0084 for one Japanese yen. Therefore, when the USD/JPY spot rate rises, it means that the futures rate is declining as US dollar would have gained against Japanese yen and therefore, one will be able to buy fewer US dollars for one Japanese yen.
Now you know how currencies are quoted in the foreign currency market. It’s time to take a look at the various benefits as well as risks associated with forex trading.