When you trade in the foreign exchange market, you either buy or sell currencies. Placing a trade in the Forex market is easy as the mechanics of a trade are very similar to those found in the other financial markets such as the stock market. Thus if you have any experience in trading, you should be able to learn to trade Forex very quickly.
The objective of Forex trading is to exchange one currency for another in the expectation that the price will change, so that the currency you bought will increase in value compared to the one you sold.
The exchange rate is simply the ratio of one currency valued against another currency. For example, the USD/CHF exchange rate indicates how many U.S. dollars can purchase one Swiss franc, or how many Swiss francs you need to buy one U.S. dollar.
How do you Read a Forex Quote?
Currencies are always quoted in pairs. The reason for this is because in every Forex transaction you are simultaneously buying one currency and selling another. Here is an example of a foreign exchange rate for the British pound versus the U.S. dollar:
The first listed currency to the left (GBP – the British pound, in this example) is known as the base currency whereas the second one is called the quote or counter currency (USD – the U.S. dollar).
When you are buying, the exchange rate tells you how much you have to pay in units of the quote currency to buy one unit of the base currency. In the example above, you have to pay 1.51258 U.S. dollars to buy 1 British pound.
When you are selling, the exchange rate tells you how many units of the quote currency you get for selling one unit of the base currency. In the example above, you will receive 1.51258 U.S. dollars when you sell 1 British pound.
The base currency is the basis for the buy or the sell. If you buy GBP/USD this simply means that you are buying the base currency and simultaneously selling the quote currency. In a nutshell: you buy EUR, you sell USD. You should buy the pair if you believe the base currency (GBP) will appreciate (gain value) relative to the quote currency (USD).
Forex Trading Terminology
When you trade Forex and want to buy, it means that you buy the base currency and sell the quote currency. If you buy, you want the base currency to rise in value and then you would sell it back at a higher price. This is called ‘going long’ or taking a ‘long position’, so in Forex the word long means buying. If you want to sell (meaning that you sell the base currency and buy the quote currency), you want the base currency to fall in value and then you would buy it back at a lower price. This is called ‘going short’ or taking a ‘short position’, so in Forex the word short means selling.
All forex quotes are quoted with two prices: the bid and ask. Almost always the bid price is lower than the ask price. The bid is the price at which market is willing to buy the base currency in exchange for the quote currency. This means the bid is the best available price at which you (the trader) will sell to the market. The ask price is the price at which market will sell the base currency in exchange for the quote currency. This means the ask price is the best available price at which you will buy from the market. Another word for ask is the offer price. The difference between the bid and the ask price is popularly known as the spread. See the below example of our bid and ask prices.
On the EUR/USD quote above, the bid price is 1.30138 and the ask price is 1.30143. If you want to sell EUR, you simply click ‘Sell by Market’ and you will sell euros at 1.30138. If you want to buy EUR, you click ‘Buy by Market’ and you will buy euros at 1.30143.
How to Start Making Money with Forex?
To keep it simple, we can start with one major currency pair that in this example is the EUR/USD meaning that the euro is the base currency for the buy or sell order. If you think that the US economy would continue to weaken, which is bad for the US dollar, you should execute a BUY EUR/USD order. By doing this, you have bought euros with the expectation that they will rise against the US dollar.
If you believe that the U.S. economy is strong and the euro will weaken against the U.S. dollar you would execute a SELL EUR/USD order. By doing so you have sold euros in the expectation that they will fall versus the US dollar.
Another example of USD/JPY , where the U.S. dollar is the base currency and thus the “basis” for the buy/sell.
If you think that the Japanese government is going to weaken the yen in order to help its export industry, you would execute a BUY USD/JPY order. By doing so you have bought U.S dollars in the expectation that they will rise versus the Japanese yen.
If you believe that Japanese investors are pulling money out of U.S. financial markets and converting all their U.S. dollars back to yen, and this will hurt the U.S. dollar, you would execute a SELL USD/JPY order. By doing so you have sold U.S dollars in the expectation that they will depreciate against the Japanese yen.