In Part 1 we introduced readers to the foreign exchange (forex) market, including a cursory glance at the size of the market and its most actively traded securities. In the following article we will explore how currency pairs are actually traded, as well as the various methods traders use to analyze and predict price movements.
In order to access the forex market, you need to find a broker that facilitates forex trading. The investment branch of your personal bank may offer forex trading services, although depending on your location, it may require significant capital before you can invest. Luckily, there are literally hundreds of reputable forex brokerages you can find online that can help you gain access to the forex market. These brokers usually offer a demo account, which allow you to test the platform before actually depositing money.
Before you choose a broker, ensure that they are regulated by a regional, national or international body and that they are in good standing. There are many online reviews that can help you determine which broker is best for you
Trading Logistics: Bid/Offer
As we mentioned previously, currency pairs consist of two parts: the base currency and the quote currency. The base currency is the first currency that appears in a currency pair, whereas the quote currency is the second currency that appears in a currency pair. For example, in the case of the GBPUSD, the GBP (British pound) is the base currency and the USD (US dollar is the quote currency).
When you are prepared to trade forex, two specific prices are used to quote a currency pair: the price that someone is willing to sell the currency (the offer price) and the price that traders want to buy a currency (the bid price). The difference between the offer price and the bid price is called a spread. Usually, traders purchase a currency pair at the offer price and sell it on the bid price. Currency pairs with a tighter bid/offer spread are usually more liquid.
The bid/offer spread described above is usually separated by units called pips. A pip reflects the price change of a specific currency pair. For example, if you are prepared to buy the GBPUSD, you may see an exchange rate like: 1.5001/1.5003. The first number quoted is the bid price and the second is the offer price. In the above example, the bid/offer spread for the GBPUSD is 2 pips.
Your ability to count pips will help you understand not only the bid/offer spread, but the relative performance of one currency versus the other.
For example, if the GBP/USD opened at 1.5000 and closed at 1.5050, that is a difference of 50 pips. If you bought GBPUSD at 1.5000 and sold it at 1.5050, you made 50 pips on the day. Since most major currency pairs are quoted to four decimal points, pips provide an easy method of tracking the performance of a currency pair.
When trading forex, you need to determine whether you want to buy or sell a currency pair. If you want to buy (which means you want to buy the base currency and sell the quote currency), you want the base currency to rise in value so you can sell it at a higher price. This is called a “long position,” where “long” simply means “buy.”
If you want to sell (which means you want to sell the base currency and buy the quote currency), you want the base currency to fall in value so you can buy it at a lower price. This is called a “short position,” where “short” simply means “sell.”
In Part 2, we introduced readers to the dynamics of forex trading. In Part 3, we will introduce readers to how forex pairs are analyzed, including a discussion on the difference between fundamental analysis and technical analysis.