Sex With Forex

When we buy something in a store, the price tag contains its price in the national currency. This situation is common for us, we pay 10 US Dollar and buy a book.
On Forex we always trade one currency against another one so regular price tag is not enough. For example, we deal with USD and EUR. In order to determine the price of the currencies, we should know the price of one US dollar denominated in the euro or the euro price denominated in the US dollars. So we need to know the rate of one currency against the other. Such rate is reflected as a quote of A/B type. In our case a quote looks like EUR/USD.
The first currency in the quote is called base currency and the second one is called quoted currency. For any currency pair on Forex, the position of a currency in the quote is strictly determined. For pair EUR and USD it is EUR/USD and NEVER USD/EUR, thus EUR is a base currency and USD is quoted currency.
How a currency position in the quote is defined? Let’s digress from Forex and discuss a country, for example, Japan. Historically every country has its own rules of quotes recording. Usually they are created to provide information in a convenient way. It is easier to say that one USD may be bought or sold at 104.78 yen than vice versa. That is why the currency rate of the Japanese yen is presented as USD/JPY. The method of currency rate recording when the price of a foreign currency is denominated in certain units of the national currency is called direct quote. The method of currency rate recording when the price of a national currency is denominated in certain units of the foreign currency is called indirect quote. In our case – USD/JPY – is a direct quote for Japan.
There is no such a concept as national currency on Forex and the main reserve currency is the US Dollar. For quotes with the US dollar the rules of currency rates recording formed in the corresponding countries are used. The concept of direct and indirect quote is used towards the USD. With some currencies the USD is a base currency, and it is called indirect quote. With other currencies the USD is a quoted currency, and it is called direct quote. For example, USD/JPY: USD is a base currency indirect quoted; GBP/USD is a direct quoted currency.
When we say that a quote A/B equals X, we mean that one unit of a base currency may be bought or sold for X units of quoted currency B. Let’s take again an example with the EUR/USD: if we say that EUR/USD equals 1.2845, we mean that we may buy or sell one EUR for 1.2845 US dollars. In other words, buy and sell transactions always refer to the base currency. Below there are examples of quotes denominated in the US Dollar.
EUR/USD 1.2845
USD/JPY 97.50
GBP/USD 1.6260
USD/CHF 1.1623
AUD/USD 0.6735
USD/CAD 1.2535
We can conclude that we can buy/sell one euro for 1.2845 US dollars and one US dollar for 97.5 JPY, etc.
It is important to know that in some lists of quotes on the Internet the authors do not specify direct and indirect quotes and imply that users are informed and understand, which currency is quoted and which one is a base one. For example, you can find a quote JPY/USD 97.50, it is an indirect quote against the USD and it means USD/JPY 97.50. Sometimes quotes against the USD are denoted by one currency, for example, JPY 97.50. So it is important to learn quotes of the currency pairs that you are going to use in trading and know what kind of quote (direct or indirect) it is against the USD. Otherwise you may take incorrect decision on a trade. For instance, the CHF is a quoted currency in the pair with the USD. The quote CHF 1.1623 means that you can buy/sell one USD for CHF 1.1623 and not vice versa.
It is also important to understand how quotes are changing. Your main aim on Forex is to buy cheaper and sell at a higher price. For direct and indirect quotes the direction of the rate changes has opposite value. For a direct quote against the USD, for example GBP/USD, the quote increase means the rise of the GBP and the fall of the USD. For indirect quote against the USD, for example USD/JPY, the increase of the quote means the rise of the USD and the fall of the JPY. So it is so important not to confuse the quote type against interesting for you currency when you close a position on Forex.
Different accuracy value (the number of digits after decimal point) is used for different quotes. Minimum quote value change is called “pip” and for different quotes it is different. For instance, for a quote EUR/USD one pip equals 0.0001 and for a quote USD/JPY one pip equals 0.01. Big figures are changing slowly.
The price of one pip denominated in the USD is of particular interest. If it is a direct quote against the USD, it is not a problem because a pip is already denominated in the USD. In case with indirect quotes against the USD, one pip value in the USD is calculated according to a special formula. We will discuss it later when start learning how to calculate profit and loss.
In this chapter all quotes were expressed in the spot (current) prices. We decided not to complicate the material introducing such concepts as buy/sell price, spread volume and cross rate. We will touch on these concepts later.