April 14, 2021 | AtoZ Markets – Forex trading is buying and selling currencies. It is a similar concept with other financial markets, such as the stock market. The goal is to exchange a currency for another in the hope of making profits when the price changes.
Making money by trading forex
When buying currencies, there is an expectation that their value will increase versus the one you sold. Forex trading is always in pairs. When you buy one, you sell the other and vice versa.
For example, a trader named Sean buys 1,000 Euros at a EUR/USD exchange rate of 1.11. After a few days, he exchanged his 1,000 Euros back to USD at the exchange rate of 1.15. Here is how he gained profit:
(1,000 Euros)(1.11)= 11,100 USD
(10,000 Euros)(1.15)= 11,150 USD
All in all, Sean gained a total of 50 USD in just a few days. The exchange rate is the ratio of a currency versus another currency. In this example, the EUR/ USD ratio is an exchange rate that indicates the number of USD you will need to buy one EUR or the number of EUR you can buy for one USD.
The base currency and the quote currency
Let us take our previous example EUR/USD = 1.11. This is an exchange rate for Euros against the US Dollar.
Here, EUR is the first and base currency. It serves as the currency pair’s base for the exchange rate, and the amount is always equal to one. USD is the second and the quote or counter currency. Currencies are quoted in line with other currencies.
In buying a currency, the exchange rate indicates how much of the quote currency you have to pay to get one base currency unit. In our example, you need to pay 1.11 USD to buy one EUR.
When you sell a currency, the exchange rate indicates how much or the quote currency you will receive when you sell one base currency unit. In our example, you will get 1.11 USD when you sell one EUR.
In short, the base currency tells us how much of the quote currency is needed to buy one base currency unit. The EUR/USD currency pair means that we are buying the base currency while selling the quote currency. In short, it is buying EUR and selling USD.
A trader should only buy a currency pair if the base currency is expected to increase versus the quote currency. On the other hand, a trader should only sell a currency pair when the base currency is likely to decrease versus the quote currency. It is made more accessible because the forex market is standardized.
Understanding the terms long and short
If you are buying a currency pair, which in essence is purchasing the base currency and selling the quote currency, you expect the base currency to rise and sell it again later at a higher price. In this case, a long position means buying.
If you are selling a currency pair, which in essence is selling the base currency and buying the quote currency, you expect the base currency to decrease and then buy it later on at a lower price. In this case, a short position means selling.
In a nutshell, long means buy, and short means sell.
Let us talk about the bid, ask, and spread
The bid is the price that your broker willing to purchase the base currency for the quote currency. It is the best price you can sell. The broker will buy something that you wish to sell at the bid price.
The ask price is the price that your broker is willing to sell the base currency for the quote currency. This price is the best and available one which you can purchase. The broker will sell something you want to buy at the asking price.
Finally, the spread is the difference you get between the bid and ask price.