The first thing to know about currency pairs is that they are always written in a
certain order. The first currency is called the base currency and the second is called
the quote currency.
Here is an example of a foreign exchange rate for the euro against the US dollar:
EUR/USD 1.3642 1.3644
The base currency is the euro and the quote currency is the dollar.
There are two prices given. The first is the bid price, which tells you how many units
of the quote currency (USD) you will get when you sell one unit of the base currency
(EUR). In this example you get 1.3642 dollars when you sell 1 euro.
The second price is the ask price, which tells you how many units of the quote
currency (USD) you have to pay to buy one unit of the base currency (EUR). In this
example you have to give 1.3644 US dollars to get 1 euro.
If you buy the EUR/USD pair you are buying euros and giving dollars. Buying is
called ‘going long’ or ‘taking a long position’.
If you sell EUR/USD you are selling euros and getting dollars. Selling is called
‘going short’ or ‘taking a short position’.
Spread And Pips
Look again at this example:
EUR/USD 1.3642 1.3644
If you were paying attention to the explanation of the bid and ask prices above, you
probably realized that if you first buy and then sell again with no change in these
prices, you lose $0.0002 (0.02 of a cent) on each dollar that you trade. This is called
The spread is measured in pips. Later, you will also see how to measure your profits
in pips. Why do we need to think in pips? The reason is simple. In the foreign
exchange market there is not a common currency in which to express values. The US
dollar may be the most frequently traded currency but it is not involved in all trades.
If you are trading cross rates, i.e. two other currencies such as EUR/GBP or any other
combination that does not involve USD, it would not make any sense at all to express
your gains and losses in terms of US dollars. Instead, we need something that is a
small percentage of the value of whatever currencies we are dealing with. We call it a
pip: percentage in point (or some say, price interest point).
One pip is the smallest part of a unit that is recorded in the price. Commonly a price
is quoted to 4 decimal places so 1 pip is 0.0001 units of the quote currency. Some
brokers are now quoting 5 places, and the Japanese yen is usually quoted to just 2
places, but for our EUR/USD example we will stay with 1 pip = 0.0001.
Here the bid price is 1.3642 and the ask price is 1.3644. So the spread, the difference
between them, is 0.0002 or 2 pips. Since the quote currency is US dollars, the pip
value in this example is US $0.0001 and the spread is US $0.0002.
$0.0002 may not seem much but in forex trading you will use leverage to deal in lots which could be $10,000 or even $100,000 each. The spread would be $2 per lot in the
first case or $20 in the second. That cuts into your profits. So you do need to take the
spread into account when trading.
Always remember that the price must change in your favor by more than the amount
of the spread before you will make a profit.
