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On the Forex, the principle is simple, you buy or sell a currency in the hope that prices will move in the right side. If you buy Euro, you hope that euro apprises. So you make a profit, because you sold your EURO higher than the price at which you have purchased. The principle is the same as in the stock market. Nevertheless, there is a big distinctness.
On the Forex, a currency is traded against another currency. We speak about an exchange rate. It indicates the amount needed in a currency to buy a unit of another currency. It is the evolution of this report, which allows you to make a profit or a loss. Thus, for the EUR / USD, if the exchange rate is 1.20, this means that with 1 euro, you get 1.20 dollars.
Assuming a trade on EUR/USD by decomposing all operations:
| Operations |
EUR |
USD |
| Buy of 1000 EUR at the exchange rate of 1.20 |
+1000 |
-1200 (10000*1.20) |
| Sell of 1000 EUR at the exchange rate of 1.30 one month later |
-1000 |
+1300 (10000*1.30) |
| Results |
0 |
+100 |
By purchasing 1000 EUR and selling it one month later, you realize a profit of $ 100. Indeed, in one month, the euro has apprises and that allows you to get more dollars with the same amount of euros.
Read a cotation:
As you have seen before, currencies are always quoted in relation to another currency. This is called a currency pair (EUR/USD, USD/CHF ….). Both currencies are linked and trade on a currency is the same as doing the reverse on the other currency. Buy EUR is the same as sell USD.
In the example above (a purchase of 1000 EUR at the exchange rate of 1.20). When you do this, you must actually pay 1.20 dollars to get 1 euro. Your account will be debited of 1200 USD to get the 1000 EUR you want.
If you want to sell Euro, it is the reverse. You will pay 1000 EUR to get the 1200 USD you want.
As you can see, a cotation is submitted like this on the Forex: EUR / USD.
The currency at the left side (EUR here), is called the base currency or domestic currency. It will serve as a basis whatever the side of your transaction buy or sell. The U.S. dollar is the rated currency or foreign currency. Thus, you can just say I buy the EUR/USD. This means that you want to buy EUR.
But there are two types of cotations, direct and indirect. In a direct cotation system, which is the case in most countries, the base currency is the domestic currency. This is true for the EUR. In indirect cotation, as the United States, the base currency is the foreign currency. That is why the EUR/USD will appear all the time in this way, even if you are in the United States.
Spread
All cotations on the Forex are decomposed on this way:
– An offer (bid): price at which you can sell
– A demand (ask): price at which you can buy
Prices vary continuously on the Forex but in any case, the bid is still lower than the ask. The difference between the two prices is called the spread.
Most often, they are market makers to ensure a bid and ask on each pair.
The offer is thus the price at which the market maker is prepared to buy the base currency against the rated currency. For you, this is the price at which you can sell the base currency.
Ask on the other hand, corresponds to the price at which the market maker is ready to sell the base currency against the rated currency. For you, this is the price at which you can buy the base currency.
Here is an example of a cotation as you can see:
|
EUR/USD |
|
|
Bid |
Ask |
|
1.4058 |
1.4060 |
|
Buy |
Sell |
Here, the bid is at 1.4058, the price at which you can sell EUR. The ask is at 1.4060, the price at which you can buy EUR. On the trading platforms, just click on Buy to buy EUR or sell or to sell euro (base currency).
Long/Short
Now that cotations have no secret for you, here are two words you hear if you regularly trade on the Forex.
Take a long position or be long, means that we purchased. In the case of EU /USD, be long on this pair means that you bought the EUR/USD (purchased the base currency EUR).
Taking a short position or be short, means that we sold. In the case of EUR/USD, be short on this pair means that you sold the EUR/USD (sold the base currency EUR)
Case study
Now a small example …
You think the U.S. economy will collapse in the coming months. What do you do?
You buy or sell the EUR/USD??
If you answered “buy”, you’re all right!! Indeed, if the U.S. economy enters in a recessionary period, the U.S. dollar will depreciate against the Euro. The exchange rate EUR/USD will rise. The EUR will apprise against the USD and one EUR will worth a greater amount of USD.