Understanding Forex Pricing
"Bid" vs. "Ask"
Forex prices, or quotes, include a "Bid" and "Ask" similar to other financial products.
The Bid is the price at which a trader is able to sell a currency pair. The Bid
price or sell price of a currency pair is always the lower price in a quote. Ask,
also sometimes referred to as "Offer", is the price at which traders are able to
buy a currency pair.
The difference between the Bid and Ask is called the "Spread" or "Pip Spread". This
is the Trader's cost per trade or per transaction. There are typically not additional
broker commissions involved in trading the Forex market, as there might be when
trading other investment markets.
Reading Price Quotes
Reading a Forex quote may seem a bit confusing at first. However, it's really quite
simple if you are able to remember two things:
- The first currency listed is the base currency
- The value of the base currency is always 1 (one)
( view figure 1 )
A quote of USD/JPY at 116.04 is to say that 1 US Dollar (USD) = 116.04 Japanese
Yen (JPY). When the US dollar is the base unit and a currency pair's price increases,
comparatively the dollar has appreciated and the other currency in the pair (usually
known as the quote currency) has weakened. Using the above USD/JPY example as a
reference, if the USD/JPY increases from 116.04 to 117.51 (147 pips), the dollar
is stronger because it will now buy more yen than before.
There are four currency pairs involving the US dollar in which the US dollar is
not the base currency. These exceptions are the Australian dollar (AUD), the British
Pound (GBP), the Euro (EUR), and the New Zealand dollar (NZD). A quote on the GBP/USD
of 1.7600 would mean that one British Pound is equal to 1.7600 US dollars. If the
price of a currency pair increases the value of the base currency in comparison
to the quote currency thus increases. Conversely, if the price of a currency pair
decreases, such is to say that the value of the base currency in comparison to quote
currency has weakened.
What Influences Price?
Forex markets and prices are mainly influenced by international trade and investment
flows. It is also influenced, but to a lesser extent, by the same factors that influence
the equity and bond markets: economic and political conditions, especially interest
rates, inflation, and political stability, or as if often the case, political instability.
Though economic factors do have long term effects, it is often the immediate reaction
that causes daily price volatility, which makes Forex trading very attractive to
intra-day traders.
Currency trading can offer investors another layer of diversification. Trading currencies
can be viewed as a means to protect against adverse movements in the equity and
bond markets, movements that of course also impact mutual funds. You should bear
in mind that trading in the off-exchange foreign currency market is one of the riskiest
forms of trading and you should only invest a small portion of your risk capital
in this market.
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