The foreign exchange, or forex markets are traded 24 hours per day, every day of the workweek, with no trading on weekends. If you’re interested in getting involved in forex as a hobby, part-time job, or full-time endeavor, it’s essential to know three basic facts about how the market operates. Beginners often get confused when they first hear some of the terminologies that are used when people trade currency pairs. The good news for newcomers is that, while the vocabulary might be unfamiliar, it’s easy to learn the important lingo in a short amount of time.
So what are the three most relevant points to learn before you begin your journey into the world of buying and selling foreign currencies? First, you have to understand how to read a quote. Second, it’s crucial to know the full meaning of the term, pip. Finally, you’ll have to figure out how price spreads work if you hope to make a profit. Here are the key facts to get you started.
Although forex trading is conducted across a decentralized global market, all foreign exchange currencies are written in a standardized way, listing the base currency first and the quote currency second. For example, in the listing, EUR/USD 1.1448, the number is the dollar cost of one euro, and that fourth digit, the 8, is one pip. It takes $1.14 and a little more to purchase one euro, based on that hypothetical listing.
In simple terms, a pip represents the smallest amount of change that a currency quote can undergo. For example, when you trade currencies that are quoted in U.S. dollars, there are four places after the decimal. The fourth place is a pip and represents one percent of one cent or .0001 of a dollar. That might not seem like a lot of money, when you use leverage and are trading perhaps thousands of dollars in multiple transactions, even a one-pip movement in price can mean a major profit or loss.
Keep in mind that you won’t always be dealing with U.S. dollars. That means a pip, by definition, has no standardized value. For instance, if the quote currency is euros, you simply look at the fourth decimal place in the quote to see what the pip value is. For 6.7938, the 8 is the pip value. If the quote rose to 6.7942, we would say that the pair (whatever the two currencies are), rose by four pips.
The concept of price spreads is relatively easy to understand because it’s based on logic. There is always a bid-ask spread on currency pairs. Bids represent what you will pay for the pair, while the ask represents what you would get if you sold the currency. Note that if you purchase USD/EUR, for example, and immediately turn around and sell it, then you’ll endure a loss equal to the spread. It’s the same as if you bought a house for $300,000 and sold it the next day for $295,000. The $5,000 spread is your loss on the deal. When forex markets are super active, bid-ask differentials are tiny. During lulls in the action, spreads tend to be larger.
Once you understand the above concepts well, you’ll have a sound footing to enter the world of currency trading. Supplement this knowledge by studying how trading works in different market conditions and using a demo account to test your trading ideas before you try risking real money.
