As you already know, the currency pairs are always made up of the base currency and the quote currency, such as GBP/NZD or USD/GBP.
The reason they are quoted in pairs is because in every foreign exchange transaction, the traders simultaneously buy one currency and sell another.
The first listed currency is known as the base currency (in the example below, it’s GBP). It always has a value of one.
The second listed currency on the right is called the counter or quote currency (in the example below, it’s USD).
If you buy GBP/USD this simply means that you are buying the base currency and simultaneously selling the quote currency. Or to put it simply, you’re buying GBP and selling U.S. Dollars.
Now, how about we throw a new term in….
An exchange rate is simply the ratio of one currency valued against another currency.
When buying, the exchange rate tells you how much you have to pay in units of the quote currency to buy 1 unit of the base currency. In the example above, you have to pay $1.27223 to buy £1.
When selling, the exchange rate tells you how many units of the quote currency you get for selling 1unit of the base currency. In the example above, you will receive $1.27223 when you sell £1.
Exchange rates in the forex market are expressed using the following format:
Base currency / Quote currency = Bid / Ask
Bid and ask, I hear you scream? Let’s cover their meanings below!
Forex brokers will quote you two different prices for a currency pair: the bid and ask price.
The bid is the price at which you can SELL the base currency.
If you want to sell something, the broker will buy it from you at the bid price.
For example, in the quote GBP/USD 1.8812/1.8815, the bid price is 1.8812. This means you sell £1 for $USD 1.8812
The ask is the price at which you can BUY the base currency.
If you want to buy something, the broker will sell (or offer) it to you at the ask price.
For example, in the quote EUR/USD 1.2812/1.2815, the ask price is 1.2815. This means you can buy €1 for $USD 1.2815.
The difference between the bid and the ask price is called the spread.
It’s just like if you were trying to sell your old monitor to a shop that buys used ones. (Now that you’re a trader you’ll need a new, bigger one!)
In order to make profit, the shop will need to buy your monitor at a price lower than the price they’ll sell it for.
If the store can sell the monitor for $600, then if the store wants to make any money, the most it can buy from you is $599. That difference of $1 is the spread.
Now, I know that’s a lot of new terms we covered!
Feel free to download the little cheat sheet below to help you memorise them!