As we have told you before, trading forex is exchanging 1 currency to another currency to get benefit from changing price rates of a currency, compared to the other one. For example :
A trader makes a profit by Buying Great Britain Pounds (GBP)
* $10,000 x 1.9800 = US $19,800
(The trader bought GBP of 10000 by selling USD of $19,800)
** $10,000 x 2.0000 = US $20,000
(The trader sold back GBP of 10000 by buying again USD of $20,000)
Why currencies are always traded in pairs ?
While forex is about exchanging a currency to another currency simultaneously (buying 1 currency and selling the other at the same instance) that is why currencies are always quoted in pairs, for example GBP/USD, EUR/USD, etc.
Cross Rate is a currency pair that does not include USD, such as GBP/JPY. Pairs that involve the EUR are called euro crosses, such as EUR/GBP. All other currency pairs (those that don't involve USD or EUR) are generally referred to as cross rates
A currency pair depicts a quotation of two different currencies. The first currency in the pair is the base currency. The second currency in the pair is labelled quote currency or counter currency. Such a quotation depicts how many units of the counter currency are needed to buy one unit of the base currency.
For example the quotation EUR/USD 1.2500, while Euro is the base currency and USD is the quote or counter currency.
It means that one euro is exchanged for 1.25 US dollar. If the quote moves from EUR/USD 1.2500 to EUR/USD 1.2510, the euro is getting stronger and the dollar weaker. On the other hand if the EUR/USD quote moves from 1.2500 to 1.2490 the euro is getting weaker while the dollar is getting stronger.
Try to understand this :
You can also say that if we Buy EUR/USD, it is the same as we are buying EUR (base currency) and at the same time we are selling USD (quote currency).
Sell EUR/USD -> Sell EUR / Buy USD
Here is another example :
Pair EUR/USD:
If you predict that EUR will be stronger than USD, then you can Buy EUR/USD.
If you predict that USD will be stronger than EUR, then you can Sell EUR/USD.
Pair USD/JPY:
If you predict that USD will be stronger than JPY, then you can Buy USD/JPY.
If you predict that JPY will be stronger than USD, then you can Sell USD/JPY.
Forex Quote, Bid, Ask (Offer), and Spread
The quotation of a currency pair usually consists of two prices.
The lower price (Bid) is the price at which a market maker or a brokerage is willing to buy the base currency in exchange for the quote currency (or we could say, bid is the trader's selling price).
The higher price (offer or ask) is the price at which a brokerage is willing to sell the base currency in exchange for the quote currency (or we could say, offer or ask is the trader's buying price). So please note that Ask or Offer is always higher than Bid
Please note :
If you open a Buy position (going Long), you will open with offer price, and will have to use bid price while selling it back (liqudating, closing, stop loss, and taking profit)
If you open a Sell position (going Short), you will open with bid price, and will have to use offer price while selling it back (liqudating, closing, stop loss, and taking profit)
| Position | Open with | Close (TP */SL **) with |
| Buy (Long) | Offer Price | Bid Price |
| Sell (Short) | Bid Price | Offer Price |
* TP = Profit Taking price
** SL = Stop Loss price
Spread is the difference between Bid and Ask price.
If the quotation of EUR/USD is 1.2293/1.2296, then the spread is EUR 0.0003 (3 points or pips)
What is Long / Short ?
Going Long means you are opening a Buy position in the expectation that the market price will move upward so you will get profit. In order to lock the profit, a trader has to sell back (liquidate or close or settle) what he has bought.
Long position = You open a Buy position and will have to Sell it again later -> Profit if the price (chart) is moving upward
For simplicity you can say Long = Buy.
Going Short means you are opening a Sell position in the expectation that the market price will move downward so you will get profit. In order to lock the profit, a trader has to buy back (liquidate or close or settle) what he has sold.
Short position = You open a Sell position and will have to Buy it again later -> Profit if the price (chart) is moving downward
For simplicity you can say Short = Sell.
| Position | Initial Action | Closing Action | Price Moving Up | Price Moving Down |
| Long | Buy | Sell | Profit | Loss |
| Short | Sell | Buy | Loss | Profit |
What are point (pip) and Contract Size (Lot) ?
A point (pip) is the smallest number in a quotation of a currency. For example if the quotation of EUR/USD is 1.2025, a pip is represented by 0.0001. However, for a different currency such as USD/JPY 116.25, a pip will be 0.01.
In order to calculate the pip value or how much is one pip, you have to know some additional information such as: trading size, leverage used, and of course the actual rate of the pair for which you want to calculate the pip value. We will explain this later.
Contract Size (or Lot) means the smallest traded quantity you use for exchanging currencies. A common size of lots are micro, mini, and standard lot. Almost all forex brokers out there offer mini and standard, while a few of them offer micro lots. The standard lot is equal to $100,000, mini is equal to $10,000, and micro is $1,000.
So if your forex broker offers you a mini lot and standard lot, you can trade in incremental of $10,000 and $100,000. for example : $20,000, $110,000, and so on.
Margin and Leverage Ratio
Margin is a performance bond, or good faith deposit, to ensure against trading losses. Trading currencies on margin lets you increase your buying power.
Leverage ratio is used to specify margin requirement to trade a spesific quantity, always in ratio, for example 1:100, 1:200, 1:500, and so on.
Here is a example:
If you have $1,000 cash in a margin account that allows 1:100 leverage, you could purchase up to $100,000 worth of currency, because you only have to post 1% of the purchase price as collateral. It could be said that to trade $100,000 worth of currency, you only need to have 1% of $100,000 (for 1:100 Leverage) as margin.
| Leverage | Margin Requirement | Used Margin (Equity Used) | Traded quantity | Profit |
| 1:1 (no leverage) | 100 % | $1,000 | $1000 | $0.1/pip |
| 1:100 | 1 % | $10 | $1000 | $0.1/pip |
The above illustation shows the benefit of using leverage. With leverage, you are able to use smaller equity (fund) to trade similar trade quantity compared to the one without leverage. Trade quantity used corresponds to your profit (loss) value as well, that is why leverage will make your profit (loss) greater !
| Leverage | Margin Requirement | Used Margin (Equity Used) | Traded quantity | Profit |
| 1:100 | 1 % | $1,000 | $100,000 | $10/pip |
| 1:200 | 0.5 % | $1,000 | $200,000 | $20/pip |
| 1:500 | 0.2 % | $1,000 | $500,000 | $50/pip |
As you can see at above illustation, with the same $1000 margin requirement used (actual cash holded by your broker for margin) and using a higher leverage, the profit/pip (or loss/pip) will be greater !
