With millions of dollars involved in foreign trading across the world under the foreign currency trading system, it is important to be aware about the forex currencies quotations system. The basic rule of this market is that you always trade in two currencies with one being sold and the second one being bought. This makes a currency pair.
Each trade involves a pair of currencies with the first one known as the base currency and the second one as the counter or the quote or the pricing currency. Now, the currency pair equations are expressed in the terms of number of units of counter currency needed to buy one unit of the base currency or the number of counter currency units that you will get in return for the sale of one unit of the base currency.
For example, if the exchange rate or the quote for the Euro, US dollar currency pair is 1.844, one needs to pay 1.844 US Dollars to buy 1 unit of Euro. Similarly, if the exchange rate of EUR/USD is 1.345, you would need 1/345 US dollars to buy 1 unit of Euro.
Again, a sell quote specifies how much units of the quote or the counter currency you will get for selling one unit of the base currency. So if the sell quote for EUR/USD is 1.844, it means that you will get 1.844 US dollars on selling one unit of the Euro. So one thing that needs to be remembered is that we always buy or sell the base currency and its value is one.
Although a large number of the currencies are traded on the foreign exchange system on a daily basis, a majority of transactions involve trading in a small group of currencies called the majors. This group is the most liquid and includes the US Dollar, the Japanese Yen, the British Pound, the Swiss Franc, the Canadian Dollar and the Australian Dollar. The pairs that do not include the US dollar are called as cross currencies. The quotations for the various currency pairs are available up to five figures with the last figure being called the pip or the point.
The trading for any currency involves two types of prices- the bid price and the ask price. While the bidding price is the price at which the buyer wants to buy a currency, the asking price is the one at which the seller wants to sell the same currency.
Let’s take an example:
Say we wish to trade in USD/JPY where the former is the base currency and the latter the counter currency.
The bid price is 120.50 yen and the ask price is120.75 yen. (This is displayed as 120.50/75 with only the last two digits of the ask price being shown on the screen.) The bid price here refers to the price at which dealers are willing to buy the base currency. Again the ask price is the price at which the dealers are willing to sell the base currency. So buying one US dollar will cost 120.50 yen and the sale of one US dollar will get us 120.75 yen. The difference between the bid and the ask price is called as the spread.
A Rising Quote And A Weakening Quote
One often tends to hear about a rising quote and a weakening quote. What do these mean? While a rising currency trading quote means that the base currency’s value has appreciated and can be used to buy more currencies, a weakening quote means the exact opposite. So while the direction of the rising quote is up, the direction of the weakening quote is down.
Spot And Forward Exchange Rates
The spot exchange rate refers to the current rate of exchange between a pair of currencies. The forward exchange rate refers to an exchange rate that is being traded today but pertains to the delivery and payment at a future pre-specified date.
Direct And Indirect Quotations
The quotes for the foreign currency pairs can be direct or indirect. Every country's Currency exchange market quotes the local currency against the USD and the other foreign currencies. This direct quotation sets the amount of the local currency required to purchase one unit of the foreign one as well as the amount of the local currency received when you sell one unit of the foreign one. So a direct quote is:
One unit of foreign currency=X number of home currency units.
An indirect quote tells us the amount of the foreign currency required for purchasing one unit of the local currency as well as the amount of foreign currency that will be received if we sell one unit of the local currency. So an indirect quote is:
One unit of home currency= X number of foreign currency units.
A proper understanding of the types of foreign currency quotations is necessary before trading in the forex market.