There are two main types of Forex quoting methods: direct quotation, and indirect quotation. Which one is best for you? That depends on your trading style. In this lesson, we will discuss the different types of quoting methods and how they work. We will also provide an overview of each method so that you can decide which one is best for you.
In order to trade in the foreign exchange market, one needs to understand the concept of direct and indirect quotation.
For better understanding the concept, let’s show an exchange rate in this article and provide an explanation of how to comprehend it properly.
EUR/USD=1.050
The exchange rate for the pair of currencies is composed of:
- EUR the base currency(always the first currency position of an exchange pair) is also called the principal currency or primary currency
- USD the bid currency (always in at the 2nd position in the exchange pair) often called secondary currency
- 1.050 – rate of exchange(expresses the amount of units of currency secondary are required for the exchange of one unit of the primary currency)
Let’s now take a closer look at the issues with the direct or indirect quotes. The primary issue, naturally is, what can we suppose under direct quotations?
Direct vs Indirect Quotation
Imagine you’re a trader in the UK and you plan to visit the USA such as, for instance, for shopping. This is the time when you must exchange GBP for US Dollars. Two scenarios can happen at the exchange counter:
- The exchange offices will provide the rate of exchange in the GBP USA ratio which is a direct quote to the UK citizen, since the ratio indicates how many USD could be exchanged for one GBP.
Example: GBP/USD = 1.2325 USD
- In the second scenario, It will be displayed in the USD/GBP format which is how much USD could be bought for a GBP. In this instance it’s an indirect quotation of the GBP as well as a direct quote of the USD.
Example: USD/GBP = 0.8113
In simplest terms, it could be said that direct quotations are offered where the local currency is used in the position of being used as the basis (primary) currency at the time it is traded. When the time comes to purchase the currency, it changes its position and is maintained as bid (secondary) foreign currency.
How to determine the exchange rate for both indirect and direct quotations?
In stock exchanges, and, naturally, also in exchange offices, exchange rates are typically stated in a single format. It can be difficult to know if the stated exchange rate for example USD / EUR = 0.92 corresponds to the value of the current traded exchange rate.
So , how can you determine if the other partner is providing us with “the appropriate” exchange rate, and is not trying to rob us?
Example:
This is how the exchange rate is traded is: Ask price – 1,100 (EUR USD)
Rate of exchange office: bid price = 0.92 (USD or EUR)
If we look at how the “exchange rate” provided to the exchange offices” will appear in the reverse format, the equation appears like this:
X=1 X=0,92Y -> Y= X/0,92 -> Y=1/0,92 -> Y=1,087 -> EUR/USD=1,087
It is evident that when the value of the currency pair that was traded was at 1.100 EUR USD the exchange office was willing to provide just 1.087 EUR / USD, which is more than one percent lower than the value currently traded.
Conclusion
It is impossible to decide if the exchange rate provided by the exchange bureau is good or bad. All is dependent on the laws that govern supply and demand i.e. whether the counterparty is willing to accept this offer at a particular time or not. This is the essence of modern day trading.
Do you have any questions about of forex Quotation?
The risk involved with forex trading online shouldn’t be overlooked. There is a chance of losing a significant amount of money if you don’t know what you’re doing. It is crucial to gain a knowledge of the market prior to you even begin investing with money. Keep reading our lessons.