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Task №4. Currency pairs, exchange rates and quotes on Forex.

All currency speculations are mainly carried out in the forex market. As Forex is a global market, it does not have a particular trading place. It is represented by a vast number of trading participants connected by communication channels. Trading deals are made via telephones and computers all over the world. The market never stops working as there are always people or institutions ready to sell or buy a currency.

As Forex is an interbank market, it takes the first place among other segments of the currency market by the trading volume. Currency market investors are attracted by exchanging one currency for another in stated volumes as it brings big profits. Almost every convertible national currency can be traded on Forex, but the most traded currencies are the US dollar (USD), euro (EUR), Japanese yen (JPY), British pound sterling (GBP) and Swiss franc (CHF). These currencies form major pairs on Forex: EUR/USD, GBP/USD, USD/CHF, and USD/JPY.

The exchange rate of one currency to another one is set as a result of the interaction between demand and supply. This is usually called a quote.
There are two quote types: direct and indirect.

A direct quote is an amount of domestic currency required to buy or sell one unit of the foreign currency. Most currency pairs are direct quotes of the US dollar against currencies of various countries.

Example:
  • USD/RUR – 33.70; it means one US dollar equals 33.70 Russian rubles;
  • USD/CHF – 1.2350; one US dollar makes up 1.2350 Swiss francs.

An indirect quote is a domestic exchange rate quoted as the foreign currency per unit of the domestic currency. Historically, the British pound, euro, Australian and New Zealand dollars as well as some other currencies have indirect quotes.

Example:
  • EUR/USD – 1.2570; one euro costs 1.2570 US dollars;
  • GBP/USD – 1.8420; one pound sterling costs 1.8420 US dollars.

Besides, there are cross pairs excluding the US dollar. For instance: EUR/JPY, GBP/CHF etc.

There are three types of currency pairs:

  • Majors;
  • Crosses;
  • Exotic.

Major currency pairs have high liquidity, they are traded most and by a vast number of players. The majors include seven pairs which are represented by a quote of the US dollar and a currency of one of the world’s most significant countries. The majors are called so because the currencies they include are considered to be the most stable.
They are:

  • EUR/USD – euro/US dollar;
  • GBP/USD – pound/ US dollar;
  • AUD/USD – Australian dollar/ US dollar;
  • NZD/USD – New Zealand dollar/ US dollar;
  • USD/JPY – US dollar/ yen;
  • USD/CHF – US dollar/ franc;
  • USD/CAD – US dollar/ Canadian dollar.

Each of these trading instruments has its features. For example, EUR/USD and GBP/USD are well amenable to technical analysis alongside fundamental one. The EUR/USD pair gained its popularity thanks to its activity with relatively smooth fluctuations. It enables traders to reap good profits in intraday and short-term trading. As a rule, EUR/USD and USD/CHF have an opposite correlation, while EUR/ USD and GBP/USD are linked directly. In other words, if an uptrend appears for the euro/dollar pair, the USD/CHF is most likely to go downwards. The connection between currency pairs is well observed on intraday charts. A trader simply needs to study history of an instrument chart. The USD/CHF movement might be forecasted based on the EUR/USD chart. Traders only need to remember that the dollar/franc pair is less stable than the euro/dollar and novices therefore need to be cautious.
Currency pairs which exclude the US dollars are called crosses. They are less active than the majors. This group includes:

  • CAD/JPY – Canadian dollar/ Japanese yen
  • CHF/JPY – Swiss franc/ Japanese yen
  • EUR/AUD – euro/ Australian dollar
  • EUR/CAD – euro/ Canadian dollar
  • EUR/CHF – euro/ Swiss franc
  • EUR/GBP – euro/ British pound
  • EUR/JPY – euro/ Japanese yen
  • EUR/NZD – euro/New Zealand dollar
  • GBP/AUD – British pound/ Australian dollar
  • GBP/CHF – British pound/ Swiss franc
  • GBP/JPY – British pound/ Japanese yen
  • NZD/JPY – New Zealand dollar/ Japanese yen

Currency pairs including the yen such as AUD/JPY, EUR/JPY, GBP/JPY, and NZD/JPY most suit traders who prefer classical trading. Newbies should be very attentive as these instruments are rather unpredictable.
National currencies of less significant countries together with the US dollar make exotic currency pairs. There are a lot of them, including USD/RUB, USD/MXN, EUR/DKK etc.
It is not recommended to use these currency pairs as they have big spreads and low liquidity. Besides, it is difficult to forecast their movement and they are not very popular.
Consequently, most market participants prefer major currencies. About 80% of all operations on the forex market are performed with the majors.

Moreover, currencies vary in value date, i.e. a day of settlement when any securities trade is official and both sides have completed their obligations for the trade. Currencies can have different value dates such as spot and forward. Spot transaction, or simply spot, is a contract of buying or selling a currency for settlement (payment and delivery) on the spot date, which is normally two business days after the trade date. For example, if an operation is performed on Tuesday, Thursday will be a value date. However, if a deal was made on Friday, all calculations will be done on Tuesday.
Value date of forward deals is settled in three or more days after the date of deal execution.

The first currency in a currency pair is called the base currency. The second currency is called the quote currency (value of the base currency is expressed in the units of the quote currency).
For example, let’s look at the USD/RUR pair. In this case the US dollar is a base currency whereas the Russian ruble is a quote currency. The US dollar value is expressed in Russian rubles.

Why is it important to know the difference between the base currency and the quote currency? The fact is that when performing a deal on a particular currency pair, traders buy or sell the base currency which plays a role of an asset. That is why, if you want to open a deal on the EUR/USD pair, you should understand which currency you buy and which currency you sell. However, some people suppose that buying euros for the US dollars is the same operation as buying US dollars for the euros. In some cases this statement is true, but it can lead to an unpleasant mistake when opening or closing a deal.

The only thing you should remember is that the first currency in a pair is the base currency which can be bought or sold depending on a deal.

Moreover, the notion of the base currency will help you make the price chart. All charts show changes of one unit of the base currency in relation to the quote currency.

For example, the EUR/USD quote will indicate that 1 euro costs a certain amount of the US dollars. If the euro price grows, the chart will move up; if the price falls, the chart will move down.
In the USD/CHF pair, the US dollar is the base currency. Thus, if the US dollar rises, the chart moves up; if the US dollar decreases, the price chart moves down.
In general, an increasing chart points to the base currency appreciation whereas a descending line indicates the base currency depreciation.

Moreover, the notion of the base currency will help you make the price chart. All charts show changes of one unit of the base currency in relation to the quote currency.

For example, the EUR/USD quote will indicate that 1 euro costs a certain amount of the US dollars. If the euro price grows, the chart will move up; if the price falls, the chart will move down.
In the USD/CHF pair, the US dollar is the base currency. Thus, if the US dollar rises, the chart moves up; if the US dollar decreases, the price chart moves down.
In general, an increasing chart points to the base currency appreciation whereas a descending line indicates the base currency depreciation.

On Forex, currency price is presented as a five-digit number. For example, EUR/USD – 1.2724 or USD/JPY – 106.74 etc. The last digit after a comma is a pip. 1 pip is the smallest possible change of a quote. For example, the USD/JPY change from 106.74 to 106.75 and the GBP/USD change from 1.8560 to 1.8561 stands for the fact that the yen dropped by 1 pip against the US dollar and the British pound gained 1 pip against the US dollar.

We have already mentioned that commercial banks, world’s central banks, brokerage companies, currency exchanges as well as investment funds and individuals are the forex market participants. However, quotes are formed on the basis of bid and ask as a result of actions of the market makers, including banks, investment funds etc. Every market participant can be either a buyer or seller.

Banks and financial organizations always give two-way price quotes where bit is on the right and ask is on the left.
In case you decide to sell a base currency, you become a seller and make a deal at the bid price and vice versa you become a buyer willing to purchase the currency and seek to make a deal at the ask price. The ask will always be higher than the bid as a dealer undertakes to buy the traded currency at the bid price and sell it at the ask price.

Spread is known as a difference between the ask and bid prices which constitutes income of a brokerage company in most cases.

Spread can be represented as:

Spread = Ask – Bid

InstaForex offers its clients a fixed spread of 3 points for the most traded currency pairs

  bid ask Spread
EUR/USD 1.2725 1.2728 0.0003 (3 points)
USD/CHF 1.2045 1.2048 0.0003 (3 points)
USD/JPY 106.75 106.78 0.03 (3 points)
GBP/USD 1.8560 1.8563 0.0003 (3 points)

Improving the number and quality of currency positions is the the major goal of the market participant.

The currency position is defined as a correlation between demand and obligations on a currency pair traded in the market. The currency position can be close and open.
You should remember that the base currency purchase is called a long position, and the sale is called a short position.
The guiding principal for long positions is “buy low, sell high”.
You open a long position when you buy the base currency. A trader closes the long position by selling the base currency.
The basic rule of short positions is “sell high, buy low” with an inverted sequence of selling and buying processes compared to the previous principal. In case a dealer expects a currency quote to start falling, he gets rid of this currency. However, he will buy it again, but at a better price when the quote becomes low enough. Thus, in both cases the dealer makes profit on the difference between the prices at which the currency was sold and bought.
You open a short position by selling the currency and you close it when you buy the currency again

An open position occurs when there is no balance between the ask and bid prices on any currency, and it can be short or long.
The position can be closed when the ask on every currency matches the bid.

Below you can see simplified schemes for balancing deals on both short and long positions:
1. A scheme to balance deals on initially opened long positions.

Let us note that InstaForex use a 10,000 lot enabling its clients to trade with the minimum deposit amount worth $1.

    bid ask
Currencypair: EUR/USD 1.2725 1.2728

Opening a long position implies purchasing the EUR (10,000 euros in volume) for 1.2728 US dollars per 1 euro.

Balance of long position:
-10000 eur -12728 usd

Closing the long position means selling the EUR (10,000 euros in volume) for 1.2750 US dollars.

Changes in balance:
-10000 eur +12750 usd
Total balance:
+10000 eur -12728 usd
-10000 eur +12750 usd
0 +22 usd
2. A scheme to balance deals on initially opened short positions.
    bid ask
Currencypair: EUR/USD 1.2725 1.2728

Opening a short position implies selling the EUR (10,000 euros in volume) for 1.2725 US dollars per 1 euro.

Balance of short position:
-10000 eur +12725 usd

The short position can be closed by repurchasing the EUR (10,000 euros in volume) for 1.2728 US dollars per 1 euro.

Changes in balance:
+10000 eur -12728 usd
Total balance:
-10000 eur +12725 usd
+10000 eur -12728 usd
0 -3 usd
Valuable information for those clients of InstaForex who trade through MetaTrader

The forex exchange market, Forex, is the interbank market where quotes are mainly delivered by the so-called market makers, which are the world’s largest banks. Data on quotes is provided through special networks of the global media majors, including Reuters, Bloomberg, Tenfor, DBC etc. to clients all over the world, namely to all banks, individuals, companies, etc., all those who work with these systems.

InstaForex made contracts with Dow Jones (Forex and stock markets new), Reuters, and e-Signal for the supply of breaking financial news.

Questions for revision
  1. What is a base currency in the currency pair? Give an example of a base asset from everyday life.
  2. What is a spread?
  3. Ask and bid: which is the price a dealer wills to buy the currency and which is the price a dealer wills to sell the currency?
  4. What does a market participant sell or buy when he makes transactions on Forex?
  5. The USD/JPY pair successively hit the levels of 111.25, 111.50, 112.40, and 113.00 during a day. Where was the price chart directed? Which currency price was rising and which one was declining?
  6. You want to open a long position on the GBP/USD pair where the rate is quoted as 1.8560 – 1.8565. What price was the deal made for? Draw up a scheme how to balance the opened position.
  7. Is there any mistake in the quotes below? Calculate the size of a spread.
  8.   bid ask Spread
    EUR/USD 1.2843 1.2849  
    USD/CHF 1.2141 1.2152  
    USD/JPY 106.98 107.04  
    GBP/USD 1.8695 1.8685  
  9. Open a position on any currency pair and give a brief description of this process. Write a scheme how to balance the position you have opened.

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