So how does someone trade in the FX market?
Let’s first consider the following:
The price of a specific currency is a reflection of how the market perceives the current and future health of the economy of a specific country. So, for example, the price of the American dollar can be seen as indicative of the perceived state of the economy of the United States at a given moment in time.
Buying currency, or American dollars, is like buying a share in the economy of the United States. Of course, you would only do so if you thought that the American economy is healthy and will further improve. If it does so, the price of its currency will rise. Selling American dollars at a higher price than the one you bought them at will result in profit.
Now, the exchange rate of a specific currency versus another currency is a reflection of the condition of the two economies when compared with each other.
In FX trading, currencies are traded in pairs, meaning that if you’re trading forex, you are simultaneously buying one currency and selling another.
To understand this, we may look at a foreign exchange rate for the euro versus the U.S. dollar:
EUR/USD = 1.07407
You should bear in mind, first, that the first listed currency (in this case the euro), is called the base currency, while the second currency (in this case the American dollar) is known as the quote currency (or term currency).
The above EUR/USD exchange rate shows that 1 EUR is equal to 1.07407 USD. This means that you need 1.07407 USD to purchase 1 EUR, or that by selling 1 EUR you can get 1.07407 USD.
Now, you should always keep in mind that the base currency is the basis for the buy or the sell. What this means is that if you are buying EUR/USD, then you are buying euros and selling American dollars. Conversely, if you are selling EUR/USD, you are selling euros and buying American dollars.
And another vital detail:
All currency trades involve both buying and selling, which means that if you open a position (if you buy EUR/USD), you have to close the position (by selling EUR/USD). So, for example, buying 100,000 EUR has to be followed by selling 100,000 EUR at a new price, keeping the profit or taking the hit according to how the pair is valued when you sell.
Going Long / Going Short
Before you open a position, you need to decide whether you want to buy or sell.
Buying a currency pair (EUR/USD for example) is going long.
Selling a currency pair (EUR/USD for example) is going short.
By buying a currency pair, say EUR/USD, you are buying the base currency and selling the quote currency. In this case, you are buying euros and selling American dollars.
You would only buy a currency pair if you expected the base currency to appreciate (gain value) against the quote currency.
Naturally, you would sell a currency pair if you expected the base currency to depreciate (fall in value) against the quote currency.
Bid / Ask
On your trading platform you will see two different prices for each currency pair. For example:
EUR/USD 1.06838 Bid 1.06853 Ask
These two different prices are the respective Bid and Ask (or Sell and Buy) prices for the currency pair.
The Bid price is the price on the left and is usually lower than the Ask price. It is the price at which you can sell a currency pair.
The Ask price (also known as the Offer price) is the price on the right. It is the price at which you can buy a currency pair.
The difference between the two prices is known as the spread.