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Currency Markets – All about the Spread
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.

MAJORS:
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

CROSSES:
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

OTHERS:
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 involved)
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 Trading Programs.
 

May 2012


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