How to read currency-pair quotes is one of the hardest things for people who are new to forex to figure out. Most of us are used to seeing one price for an item, like $1.89 for a loaf of bread or $39.50 per share for a stock, etc. But in these situations, we are trading U.S. dollars for real goods. It can be hard to understand how to buy one currency with another, but this article should help clear up some of your questions.
How Foreign Exchange Works
Currency pairs are used to trade currencies. For example, the U.S. dollar (USD) and the Japanese yen (JPY), which is written as USD/JPY, are a common currency pair. A quote for this pair of currencies could look something like this: USD/JPY 116.01/05. This means that the ask price is 116.05 and the bid price is 116.01. (replace the final two digits of the first number with the number appearing after the slash).
The bid price tells you how many units of the counter currency (the currency listed after the slash) you can get for one unit of the base currency (the currency listed first). In this case, one U.S. dollar would get you 116.01 Japanese yen. The ask price tells you how many units of the counter currency you need to buy one unit of the base currency. In this case, the market maker is willing to give you 116.05 Japanese yen for one U.S. dollar.
If you've been paying attention, you've probably noticed that the market maker buys dollars for 116.01 yen and sells them for 116.05. The difference between the ask price and the bid price is called the spread, and it is measured in pips. Each decimal point difference between the bid and the ask is worth one pip, so the spread in this case is four pips.
Let's look at the Euro-U.S. dollar (EUR/USD) pair as another example. First, you'll see that the Euro comes first on the list. This means that it is the base currency, not the U.S. dollar. Usually, the U.S. dollar is the base currency, but not when compared to the "Queen's currencies" of the Great Britain pound (GBP), the Australian dollar (AUD), or the New Zealand dollar (NZD), or when compared to the Euro (EUR).
Currency Pairs Used Often
There are four "major" currency pairs: EUR/USD, USD/JPY, GBP/USD, and USD/CHF. There are also three "commodity" currency pairs: USD/CAD, AUD/USD, and NZD/USD. That's a total of eight currencies, which is a lot easier to keep track of than the more than 13,000 stocks that are actively traded on the U.S. stock market.
You may have also noticed that the U.S. dollar is used in all of the currency pairs above. Cross currencies are currency pairs that don't use the USD as either the base currency or the counter currency. EUR/JPY or GBP/CHF are two examples. It's important to remember that not all forex brokers deal in all currency pairs. If you have a specific strategy in mind, you should make sure your broker deals in the pairs you want to trade.
