Trading forex requires an understanding of forex basics. The basics of forex include concepts such as that of quotes, spread, lots, and pip.
In order to be able to fully operate in the forex market, you need to master these basic concepts.
The first concept of forex basics to be examined are forex quotes. A forex quote is a price for a particular forex pair. Each currency pair contains the base and counter currencies. The price of a pair is how much of the counter currency is required to buy 1 unit of the base currency.
A currency pair at any point in time will have two prices, the bid and ask prices.
The bid price is usually lower than the ask price and is the price at which buyers are willing to pay for the pair. It is the price at which a sell order by you will be filled.
The ask price is the price at which sellers are willing to sell the pair. It is the price at which a buy order will be filled.
The spread is the difference between the bid and ask prices. The spread is the charge levied by the broker for every position taken. Therefore, it is how they make profit.
Different brokers charge different spreads and this can significantly affect your trading.
A lot refers to the amount of units that is being traded. Most forex brokers today provide up to four different lot sizes for the trader. These are:
1. Standard lot
2. Mini lot
3. Micro lot
4. Nano lot
A standard lot is defined as 100,000 units of the base currency. For example, when you buy 1 standard lot of EUR/USD, you are purchasing 100,000 euros with U.S. dollars.
A mini lot is defined as 10,000 units of the base currency. For example, when you buy 1 mini lot of NZD/USD, you are purchasing 10,000 New Zealand dollars with U.S. dollars.
A micro lot is defined as 1,000 units of the base currency. For example,
when you buy 1 micro lot of USD/ZAR, you are purchasing 1,000 U.S. dollars with South African Rand.
A nano lot is defined as 100 units of the base currency. For example,
when you buy 1 nano lot of GBP/CAD, you are purchasing 100 British pounds with Canadian dollars. Nano lots are mostly offered in cent accounts by brokers.
The lot size decreases by a factor of 10 from standard, to mini, to micro,
and finally to nano.
A pip, also known as “percentage in point”, is a very small measure of
the change in a currency pair in the forex market. It can be measured in terms of the quote or in terms of the underlying (base) currency.
A pip is a standardized unit and is the smallest amount by which a currency quote can change. A pip represents a 0.0001 variation (either increase or decrease) in currency pairs based on four decimals and a 0.01 variation in currency pairs based on two decimals.
You can calculate the value of a pip using the formula below:
Pip = (0.0001/Value of currency pair) X No of units traded X Exchange rate of base currency to USD
It follows that if the base currency is USD then the exchange rate is not
needed. Also, if USD is the counter currency then, the value for one pip is always $10.
For calculators to help in calculating forex parameters, click here.
Buying and Selling
In the forex market prices oscillate. As a result, the pair can either increase in value or decrease in value. The goal of forex trading is to take advantage of these changes in prices as the case may be.
To achieve this goal, the direction in which the currency price will go (up or down) must be determined and the appropriate action taken. It is this that leads to the concept of buying and selling.
Furthermore, if it is determined that the price of the pair will appreciate, you buy the pair i.e a long position is taken. Alternatively, if it is determined that the price of the pair will depreciate, then the pair is sold i.e a short position is taken.
So, if a pair say EUR/USD is bought (going long), the counter currency is sold
and the base currency is bought. And if the pair is sold, the base currency is sold and the counter currency is bought.
In conclusion, forex basics are the foundation on which you can build up your knowledge of the currency market. To learn more about forex, read more of our blog.
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