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Reading a Quote and Understanding the Jargon
One of the biggest sources of confusion for those new to the currency market is
the standard for quoting currencies. In this section, we'll go over currency
quotations and how they work in currency pair trades.
Reading a Quote
When a currency is quoted, it is done in relation to another currency, so that the
value of one is reflected through the value of another. Therefore, if you are trying
to determine the exchange rate between the U.S. dollar (USD) and the Japanese
yen (JPY), the quote would look like this:
USD/JPY = 119.50
This is referred to as a currency pair. The currency to the left of the slash is the
base currency, while the currency on the right is called the quote or counter
currency. The base currency (in this case, the U.S. dollar) is always equal to one
unit (in this case, US$1), and the quoted currency (in this case, the Japanese
yen) is what that one base unit is equivalent to in the other currency. The quote
means that US$1 = 119.50 Japanese yen. In other words, US$1 can buy 119.50
Japanese yen.
Direct Quote vs. Indirect Quote
There are two ways to quote a currency pair, either directly or indirectly. A direct
quote is simply a currency pair in which the domestic currency is the base
currency; while an indirect quote, is a currency pair where the domestic currency
is the quoted currency. So if you were looking at the Canadian dollar as the
domestic currency and U.S. dollar as the foreign currency, a direct quote would
be CAD/USD, while an indirect quote would be USD/CAD. The direct quote
varies the foreign currency, and the quoted, or domestic currency, remains fixed
at one unit. In the indirect quote, on the other hand, the domestic currency is
variable and the foreign currency is fixed at one unit.
For example, if Canada is the domestic currency, a direct quote would be 0.85
CAD/USD, which means with C$1, you can purchase US$0.85. The indirect
quote for this would be the inverse (1/0.85), which is 1.18 USD/CAD and means
that USD$1 will purchase C$1.18.
In the forex spot market, most currencies are traded against the U.S. dollar, and
the U.S. dollar is frequently the base currency in the currency pair. In these
cases, it is called a direct quote. This would apply to the above USD/JPY
currency pair, which indicates that US$1 is equal to 119.50 Japanese yen.
However, not all currencies have the U.S. dollar as the base. The Queen's
currencies - those currencies that historically have had a tie with Britain, such as
the British pound, Australian Dollar and New Zealand dollar - are all quoted as
the base currency against the U.S. dollar. The euro, which is relatively new, is
quoted the same way as well. In these cases, the U.S. dollar is the counter
currency, and the exchange rate is referred to as an indirect quote. This is why
the EUR/USD quote is given as 1.25, for example, because it means that one
euro is the equivalent of 1.25 U.S. dollars.
Most currency exchange rates are quoted out to four digits after the decimal
place, with the exception of the Japanese yen (JPY), which is quoted out to two
decimal places.
Cross Currency
When a currency quote is given without the U.S. dollar as one of its components,
this is called a cross currency. The most common cross currency pairs are the
EUR/GBP, EUR/CHF and EUR/JPY. These currency pairs expand the trading
possibilities in the forex market, but it is important to note that they do not have
as much of a following (for example, not as actively traded) as pairs that include
the U.S. dollar, which also are called the majors. (For more on cross currency,
see Make The Currency Cross Your Boss.)
Bid and Ask
As with most trading in the financial markets, when you are trading a currency
pair there is a bid price (buy) and an ask price (sell). Again, these are in relation
to the base currency. When buying a currency pair (going long), the ask price
refers to the amount of quoted currency that has to be paid in order to buy one
unit of the base currency, or how much the market will sell one unit of the base
currency for in relation to the quoted currency.
The bid price is used when selling a currency pair (going short) and reflects how
much of the quoted currency will be obtained when selling one unit of the base
currency, or how much the market will pay for the quoted currency in relation to
the base currency.
The quote before the slash is the bid price, and the two digits after the slash
represent the ask price (only the last two digits of the full price are typically
quoted). Note that the bid price is always smaller than the ask price. Let's look at
an example:
USD/CAD = 1.2000/05
Bid = 1.2000
Ask= 1.2005
If you want to buy this currency pair, this means that you intend to buy the base
currency and are therefore looking at the ask price to see how much (in
Canadian dollars) the market will charge for U.S. dollars. According to the ask
price, you can buy one U.S. dollar with 1.2005 Canadian dollars.
However, in order to sell this currency pair, or sell the base currency in exchange
for the quoted currency, you would look at the bid price. It tells you that the
market will buy US$1 base currency (you will be selling the market the base
currency) for a price equivalent to 1.2000 Canadian dollars, which is the quoted
currency.
Whichever currency is quoted first (the base currency) is always the one in which
the transaction is being conducted. You either buy or sell the base currency.
Depending on what currency you want to use to buy or sell the base with, you
refer to the corresponding currency pair spot exchange rate to determine the
price.
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