Currency Markets – All about the Spread
Expanding the group of currency pairs you follow can
improve your profit potential and allow for increased trading activity in the
Forex market. As with all markets, time of day for trading will vary - currency
pair by currency pair. If you are looking to begin trading the Forex market –
spend time studying prior to even getting a Forex broker.
We find the following currency pairs provide most trading
activity from 8am to 4pm Eastern Time and are the pairs focused on by the
moderators inside our
Forex Trading Room.
EUR/USD = Euro / U.S. dollar
GBP/USD = British pound / U.S. dollar
USD/CHF = U.S. dollar / Swiss franc
USD/JPY = U.S. dollar / Japanese yen
USD/CAD = U.S. dollar / Canadian dollar
AUD/USD = Australian dollar / U.S. dollar
EUR/JPY = Euro / Japanese yen
GBP/JPY = British pound / Japanese yen
CHF/JPY = Swiss franc / Japanese yen
AUD/JPY = Australian dollar / Japanese yen
EUR/AUD = Euro / Australian dollar
EUR/CAD = Euro / Canadian dollar
GBP/CAD = British pound / Canadian dollar
What is a Pip? Pip stands for ‘price interest point’ and refers to the smallest
incremental price move of a currency. Tick size is the smallest possible change
in price. Understanding how to calculate pip value and profit/loss requires a
basic knowledge of currency pairs and crosses.
When trading Forex, all trades result in the simultaneous
purchase of one currency and the sale of another. This necessitates a slightly
different mode of thinking than what you might be accustomed to. You would
execute a trade only at a time when you expect the currencies you are buying to
increase in value relative to the one you are selling. If the currency you are
buying does increase in value, you must sell the other currency back in order to
lock in a profit. An open trade or open position, is a trade in which a trader
has bought or sold a particular currency pair and has not yet sold or bought
back the equivalent amount to close the position.
The cost of establishing a position is determined by the
‘spread’. Prices are always quoted using five numbers (for example: 134.85) with
the final digit of which is referred to as a pip. For example, if USD/JPY was
quoted with a bid of 134.85 and ask of 134.90, the five-pip spread is the cost
of trading this position. Therefore, the trader must recover the five-pip cost
from his or her profits, necessitating a favorable move in the position in order
simply to break even.
Direct Rates: GBP/USD, EUR/USD, AUD/USD, NZD/USD
Currency pairs where the USD is the quote currency are referred to as direct
rates and holds true for currencies such as EUR, GBP, NZD and AUD.
Pip value for direct rates are calculated according to the following Formula:
Pip = lot size x tick size
Example for 100,000 GBP/USD contract: 1 pip = 100,000 (lot size) x .0001 (tick
size) = $10.00 USD
Indirect Rates: USD/JPY, USD/CHF, USD/CAD
Pip values for indirect rates are calculated according to the following Formula:
pip = lot size x tick size / current rate.
Example for 100,000 USD/JPY contracts currently trading at 120.50: 1 pip =
100,000 (lot size) x .01 (tick size) / 120.50 (current rate) = USD $8.30
Most currencies are traded indirectly against the USD and these
pairs are referred to as indirect rates. An example is the USD/CAD. The USD is
the ‘base currency’, the CAD is the ‘quote currency’ and the rate quote is
expressed as units per USD. An example of an indirect rate is as follows:
USD/CAD trading at 1.1500 means that 1 USD = 1.1500 CAD.
Cross Rates: GBP/JPY, EUR/JPY, AUD/JPY, EUR/GBP, GBP/CHF (Where the US Dollar is not
Currency pairs that do not involve the USD are referred to as
cross rates. Even though the USD is not represented in the quote, the USD rate
is usually used in the quote calculation. An example of a cross rate is the EUR/GBP.
Again, the EUR is the base currency and the GBP is the quote currency.
When new to forex market trading, you have a lot to learn – just as with
any market or any new career. Take your time, do your homework and demo trade
extensively prior to making any live trades. Participate in professional Forex