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Forex Basics – The Anatomy of a Currency Pair

Forex Basics – The Anatomy of a Currency Pair

When you conduct a forex trade, you either buy or sell one currency against another, which is called a currency pair. So if you buy US dollars with your Euros, the pair would be listed in the format EUR/USD and would have a value, for example EUR/USD 1.2327. So for each euro you trade, you receive 1.2327 dollars. However in reality it is not as straightforward as this, so we will discuss the terminology involved in a currency pair and how a currency transaction works.

Base Currency and Quote Currency

The base currency is the first listed in the currency pair and shows how valuable it is in relation to the second currency, also called the quote currency. So in the example above, EUR is considered the base currency, and USD the quote currency, and 1 USD is worth 0.8112 euros. Most of the time in the forex market the USD is listed as the base currency, with the euro and British pound being a couple exceptions. To calculate how many dollars you could buy with 1 euro, you divide the base currency by the quote currency, so in this example it would be 1 (USD)/1.2327 (EUR), or 0.8112.

Bid Price, Ask Price and Spreads

Currency quotes are expressed in terms of bid price and ask price. The bid price is the price at which the market will buy a currency pair, and the ask price is the price at which the market will sell a currency pair. The difference between the two is called the spread. So instead of the currency pair being listed at just USD/EUR 1.2327, you will see it listed as EUR/USD 1.2327/30. This means you can buy 1.2327 dollars with one euro, and sell 1.2330 dollars for one euro. The spread amount in this example is 1.2330-1.2327 = 0.0003.

So that in a nutshell describes how currency pairs operate. It may seem like the spread can be a disadvantage when trading but that is offset by forex brokers not charging commissions or other fees.

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