The idea of the forex market is to buy and sell currencies. Trading is essentially similar in any market. If you are used to trading stocks, this might already be second nature to you. While there are differences in every market, this obviously will be easier for those with some kind of market experience.
The idea is that one buys or sells a currency with the idea that the price will change, which will net them a profit. It is, of course, up to the trader, to have an idea of how much the currency will change, and take profit while managing risk accordingly. Of course, if you purchase a currency, the idea is that it will increase against the currency that you sold, for whatever reason, whether it is a chart play or because of a specific catalyst, or another reason.
An exchange rate is the rate at which one currency “exchanges” for another. It is the value of one currency against another.
Example: The USD/CHF exchange rate indicates how many U.S. dollars would be required to purchase just one Swiss franc, and in turn, vice versa – or how many Swiss francs it would take to purchase one dollar.
Reading a Forex Quote:
Currencies are always quoted in pairs. This isn’t the same as purchasing a stock, where one simply searches for a stock symbol and decides to purchase a certain amount of shares for a certain amount of money. Currency trading always involves a PAIR of currencies, so it is always quoted as such. This is because you are buying a currency while selling another simultaneously. This is how the entire forex market operates.
If you were to look at the foreign exchange rate for the British pound against the U.S. dollar, it would look like this.
GBP/USD forex quote
The base currency is the currency to the left of the slash, while the currency on the right is known as the counter currency, or quote currency.
If you choose to buy, here’s what you must understand: you are deciding to pay in units of the QUOTE currency, to buy a unit of the base currency. For example, if you purchase the above quote, you might be paying 1.5 dollars to buy 1 British pound.
Afterwards, if you were to sell, you would receive that 1.5 dollars back.
The “base” currency is called such because it is essentially the basis for the trade. The same with any other currency. If it was EUR/USD, you would be purchasing EUR, and selling USD.
The idea here is that if you believe that the base currency will increase in value, or appreciate, for whatever reason, you would buy. Similarly, if for whatever reason, you feel that the base currency will decrease, you would want to sell.
Obviously, the trader would want to have a strategy before they trade, and decide whether they believe a certain currency will appreciate or depreciate, and thus, whether they would be buying or selling.
Taking a “long position” means that a trader believes that whatever they are buying will increase in value. This jargon is not only used in the forex market, but is utilized in every market, whether it’s the stock market, cryptocurrency market, or otherwise. “Going long” essentially means that the trader or investor believes that this position will appreciate in value, in the long-term. Of course, “long-term” might be relative, because for some people this might be one week, for other traders it might mean one month, and for still others, it could mean an entire year.
The point is that long = buy.
For those that want to sell, they might say that they are “going short”. This obviously means that they believe that the currency will decrease in value, and the trader wishes to profit in the opposite direction – by betting that it will decrease, and sell when it does.
The Bid, Ask, and Spread
The bid is the price which your broker is willing to buy the base currency, in exchange for the quote currency. The ask price is the best price that you can purchase from the market. The spread is the important because it is the difference between the bid and the ask, and how far apart this is can affect liquidity, and investor interest. We discussed earlier how the tighter the spread is, the more interest there is in the market because both traders and investors can feel as though there is enough interest for them to continue trading, while knowing that they are taking a minimal risk, since there are simultaneously enough buyers and sellers in the market for them to trade large quantities without worrying about a sudden fluctuation in price or loss.
For the EUR/USD quote, imagine that the bid is 1.3776 and the ask is 1.38224.
If you would want to sell EUR, you would sell it at 1.3776.
Similarly, if you wanted to purchase EUR, you would be buying it at 1.38224.