by Christopher Temple
There really isn’t any substitute for climbing that tremendously slippery slope called The Learning Curve. If you learn the basics, and take in as much forex trading information as you possibly can, you’ll save yourself a fortune. You can just jump straight in, as I did, but eventually you’ll still have to climb the dreaded learning curve anyway. It will be a tad easier – but only because your pockets are empty! So learn to trade the forex markets first – not last! This forex newcomer’s article teaches currency pairs and spreads, and is for the complete forex beginner.
To make that allegedly easy money, we trade a currencies by buying at one price and re-selling it later at a different (and more profitable) price – exactly as though wheeling and dealing in lumber or oil. If we have traded well, our second transaction will leave us with a healthy profit which is represented by the difference between buying and selling prices. A minor complication is that at any time, there are two prices to cope with, depending on whether we are buying or selling. An added complication is that a currency can have many prices, depending on what other currency it is being compared to.
A currency exchange rate is invariably referred to as a currency pair. For example, the EUR/USD refers to the Euro (the European currency) and its rate against the US Dollar. The first currency in a pair is always the base currency, and the second is the quote currency. Thus the EUR/USD exchange rate indicates how many US Dollars a buyer will require to purchase one Euro, or conversely how many Dollars he will be receive when he sells one Euro.
In numerical terms, a currency exchange rate is typically given as a pair of numbers consisting of the bid price and the ask price (eg: 0.8325/29). The ask price is used when buying into currency pair and represents what is paid in the quote currency to obtain a single unit of the base currency. The bid price is used when selling a pair and represents what will be received in the quote currency when selling one unit of the base currency.
The bid is always lower than the ask. In currency markets, a simple presentation of the exchange rate is used, as in my example above (eg: 0.8325/29). The first figure (ahead of the slash) is the bid price (what you would receive in dollars when you sell euros). The second figure (after the slash) is the ask (what you will pay in USD if you want to buy euros).
The ask price is obtained by removing the last two digits from the first component (the bid) and replacing them with the second component. In my example, the ask price is 0.8329. As another example, 0.8199/02 means a bid price of 0.8199 and (since the ask price is always higher) here we need to amend the second digit up by one as well, so that the price becomes 0.8203. For some currency pairs it is common to quote rates in units of 100, this is the case with USD/JPY (US dollar against the Japanese Yen).
These small units or basis points are called PIPS by traders the world over. So in the examples above, the difference between buy and sell prices (Bid and Ask) are 4 pips and 3 pips respectively. This difference between bid and the ask prices is always referred to as the spread. The spread is effectively the fee that the broker or online spread-betting service is charging to process your trade.
For popular currency pairs like the GBP/USD (UK pound sterling against the dollar), the spread can at times be as low as just three pips. If you buy into a currency with a 3-point spread, and you are betting (say) 10 dollars a pip, then you will instantly show a paper loss of 30 dollars in your account, and the price would have to rise 4 pips (40 dollars) before a profit would be made. The spread is a sort of proportional charge – the more cash you trade per pip, the more you will have to pay in fees.
This fixed spread does however offer a major benefit, in that if you make long trades over days or weeks where a rise of 100-plus pips is conceivable in a single trade, then you will still only pay an initial 3-pip spread! That spread is only a tiny proportion of your profit on the trade. But think of the poor day-trader who will often make several trades in a day and for each trade he looks for profits in single figures (say 8 to 10 pips per trade). For him, that little 3-pip spread is effectively a 30% tax on his income!
Newcomers to forex trading would be well-advised to search for the best, most competitive rate (lowest spread), especially if they are starting out with very small bets (say one or two dollars per pip). If they are going to start small, they are less likely to be penalised if they use a larger online broker or spread-better who will be keen to get their future business. The more traditional brokers (even those with an online presence) will usually charge a wider spread for smaller trades because their own costs are proportionately higher.
All newcomers are also advised to stick to the three or four most popular currency pairs, not only because these will give them the lowest costs (spread) but because liquidity and volatility are usually higher too, making profitable trades that much easier to find and profit from.
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