What is in a Foreign Currency Price?
How to read foreign exchange quotes
In the basic stock day trading section, I discussed concepts such as of bid and ask. Do these concepts still apply to currency trading? The answer is "yes." Let's see how this works.
The price of a currency (foreign exchange rate) is always given in terms of another currency. That is why you will hear that currencies trade in "pairs." In the Interbank market, the currency pairs are standardized; for example, euros in terms of dollars, dollars in terms of Japanese Yen, and not the other way around. An example can make this clearer. Let's say that the price of the euro versus the dollar is:
EUR/USD = 1.2125
This means (reading from left to right) that 1 euro is equal to 1.2125 US Dollars. The currency to the left of the forward slash ("/") is called the "base currency" and the one on the right is called the "quote currency" (also called the "counter currency"). Currency quotes are thus given for the base currency in terms of the quote currency; i.e., euros in terms of dollars - 1 euro is equal to 1.2125 dollars. Day traders new to currencies might be confused trying to interpret the quote above mathematically; in other words, thinking that EUR/USD means euros per dollar (it does not - it actually means dollars per euro!!!). This is a mistake that is quickly avoided when you simply memorize to add a one (1) in front of the EUR/USD and understand that the number on the right (1.2125), beside the second currency, is the number of units of the second currency; in other words, the quote EUR/USD = 1.2125 means that 1 EUR is equal to 1.2125 USD. Memorize this before you start day trading currencies, and you will never have another problem interpreting the price of a foreign currency again.
Why, you might ask, is the quote not simply EUR/USD = 1.21; in other words, why not simplify matters and take the quote to the cent level (two decimal places) and not to the thousandth of a cent level (four decimal places). The reason is that currencies are traded in large chunks and a move of a fraction of a cent can represent a sizable amount for many currency pairs. I will discuss this further later.
There are a few exceptions to prices with four decimal places; for example, the quote of the dollar versus the yen is taken only to two decimal places. Let's see what this means?
USD/JPY = 107.65
This means that (reading from left to right) 1 USD is equal to 107.65 JPY (Japanese Yen).
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