Ever since I started this forex trading blog, I’ve gotten some amazing feedback from you readers. Infact, some of the reviews of my have been so tremendous I’ve felt my head expanding as big as cyberspace itself. Now I don’t want to jump ahead of myself, but I’ve a feeling some of you would like to join the forex trade bandwagon. But you don’t know how. So,being the nice guy that I am, I’m going to do a two part series on Forex Trading Basics-Top To Bottom starting with Part I. It’s my version of Forex Trading 101 where you’ll be fed the fundamentals of forex trading. I basically want to feed you the milk before you start chewing the bones of the forex trade. You’d be crazy to take the plunge without the necessary tools right?
So let’s get started with:
Exchange One Currency For Another
The only motivation behind forex trading is to exchange one currency for another. That’s all!- Nothing sinister going on here. By exchanging one currency for another, you’re hoping that the price will change so that the currency that you bought initially will shoot up in value as against the currency that you sold. Let’s take a look at the little graph below:
| Trader’s Action | EUR | USD |
| You purchase 10,000 euros at the EUR/USD exchange rate of 1.1800 | +10,000 | -11,800* |
| Two weeks later, you exchange your 10,000 euros back into U.S. dollar at the exchange rate of 1.2500 | -10,000 | +12,500** |
| You earn a profit of $700 | 0 | +700 |
** EUR 10,000 x 1.25 = US $12,500
What you see here is the exchange rate in action. The exchange rate is simply the ratio of one currency valued against another currency. Per this definition, the USD/CHF shows how many U.S dollars need to buy one Swiss franc or how many Swiss Francs you need to buy one U.S dollar.
You Need To Know How To Read A Forex Quote
If you want to make it as a forex trader,you need to know how to read a forex quote. There is no getting around this one. If you can’t do this,you’re in trouble. Seriously though, currencies have always been quoted in pairs since time memorial. I’m sure you’re aware of famous partners such as GBP/USD AND USD/JPY . They’re perfect examples of a forex quote. Now why’re they quoted in pairs? Because in every forex transaction, you’re doing two things at the same time – buying one currency and selling the other. Let’s take a look at British Pound/U.S.Dollar
The first currency listed to the left of the slash symbol is termed the base currency(In this case the British Pound). While the second currency on the right is labelled the counter or quote currency(In this case U.S.dollar).
When you buy, the exchange rate lets you know how many units of the quote currency you need to pay to get one unit of the base currency. So going by the above example, you have to pay 1.51258 U.S. dollars to buy 1 British pound.
But it’s a little bit different when you sell. Here, the exchange rate lets you know how many units of the quote currency you get for selling the base. Again going by the GBP/USD pair, you will receive 1.51258 U.S. dollars when you sell 1 British pound.
And please get this once and for all. the base currency is the main catalyst for the buy or sell routine. For instance if you buy EUR/USD, you’re buying the base currency and selling the quote currency at the same time, In Tarzan talk, “Buy EUR, sell USD.” You buy the pair if your trading instincts tell you that the base currency(EUR) will gain in value as against the quote currency (USD). You sell the pair when those same trading instincts scream in your head that the base currency will take a dip as against the quote currency.
Know How To Go Long/Short
You need to know how to go long or short. In other words, you must decide whether you want to buy or sell. If you want to buy(buy the base currency and sell the quote currency), let the base currency rise in value and then sell it back at a higher price. And if you want to sell(sell base currency/buy quote currency), the value of the base currency must drop for you sell it back at a lower price. So remember these two formulas: long=buy. short=sell . Let’s take a look at theAUD/JPY graphic below.
This is a classic illustration of entering long/short using AUD/JPY in the 1hr time frame. You go long when you spot engulfed candlesticks. By engulfed candlesticks,when a bull(strong candlestick) engulfs a bear(white candlestick. This suggests the value has risen,and it’s time to buy.This is exactly the case at the lines of support and resistance where the strong bull(white candlestick) engulfs the bear(blue candlestick). The bulls are basically saying the value of the currency has risen,and so they’re putting in a bid to buy. When you see something like this,why waste time?
As the short entries suggest,the value of the currency has dropped enough in value. So it’s time to sell. That’s according to the bears. Since they helped drive the price down,they’re now in the driver’s seat calling the shorts.
Know How To Ask/Bid
Not only should you know how to ask/bid as a trader,but you should know the difference between these two terms. For the record,all forex quotes are quoted with two prices – The bid and the ask. Let’s see the graphic showing both terms.
This EUR/USD graphic illustrates the bid/ask scenario.. The bid is the price at which you’re willing to buy the base currency in exchange for the quote currency. It is the best currency at which you(the trader) will to sell to the market.
Th ask is the price at which the broker is willing to sell the base currency in exchange for the quote currency. It is the best currency at which you(the trader) will buy from the market. The ask is also known as the offer price. After all,if you want something you ask for it.Right? Also,let’s make one thing absolutely clear: The bid price is usually lower than the ask price. Try do it the other way round, and you’re sure to get a massive rejection from your MT4 software.
Wanna know the difference between the bid and the ask price? It’s popularly known as the spread. On the EUR/USD quote above, the bid price is 1.34568 and the ask price is 1.34588 The ten pip difference is known as the spread, which we will be getting to next..
What Do We Mean by Pips In Forex Trade?
A pip is a popular acronym for price interest point. Basically the pip measures the amount of change in the exchange rate for a currency pair.Most currency pairs are rounded up to four decimal places, so that one pip is 0.0001. The only exception is the yen,which is rounded up to two decimal places(0.01). So keep that in mind in case you decide to experiment.
However, forex brokers are getting sexy these days. They’re now offering fractional pips called pipettes to add extra precision when quoting exchange rates for certain currency pairs. Just so, you know a fractional pip is equivalent to 1/10 of a pip.So for instance, you can round EUR/USD currency pair to five decimal places while the yen moves up a notch to three decimal places. Makes life more for you yen traders out there . Doesn’t it?
Forex traders also use pips to make reference to gains and losses they’ve sustained in their trades. So when you hear a trader say “I made 40 pips in this trade,” he’s basically saying “ he profited by 40 pips. However, the actual cash representation of these pips depends squarely on their value.
Speaking of which:
How Do I Determine Monetary Value Of Pip?
“How Do I Determine Monetary Value Of Pip” translates into “How Do I Calculate Profits.”Well, the monetary value of a pip is dependent on three crucial factors: the currency pair being traded, the size of the trade, and the exchange rate. Let’s say a $300,000 trade between the USD/CAD pair closes at 1.0568. Here is how the profit is calculated.
- Determine the number of CAD each pip represents by multiplying the amount of the trade by 1 pip as follows:
300,000 x 0.0001 = 30 CAD per pip
- Divide the number of CAD per pip by the closing exchange rate to arrive at the number of USD per pip:
30 ÷ 1.0568 = 28.39 USD per pip
- Multiply the number of pips gained, by the value of each pip in USD to arrive at the total loss / profit for the trade:
20 x 28.39 = $567.80 USD profit
Seems fairly straight forward isn’t it?
Just to solidify your understanding of the calculation process, let me show you another example using the EUR/GBP pair and using the same steps above.
| Currency Pair | Exchange Rate at Close | Pip Change | Trade Amount |
| EUR/GBP | 0.8714 | +29 | 350,000 EUR |
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Hopefully this example helped smooth things.
If you want to find why the forex trade is the biggest industry on the planet refer to Why Forex Trade Is So Popular?
That’s a wrap for “Forex Trading Basics From Top To Bottom Part I.” Hopefully you now have a feel for what you need to know to get started as a forex trader.. Next I’ll share with you more things you need to know to make money as a forex trader in “Forex Trading Basics From Top To Bottom Part II.” Til next time take care.
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