When we buy a good in the shop the price tag of this good reflects its price in the national currency. This situation is common for us; we pay 10 US Dollar and buy a book.
At Forex we always trade one currency against the other that is why regular price tag is not enough here. For example, we deal with USD and EUR. In order to value currencies’ price we need to know the price for one USD, denominated in EUR or EUR price denominated in USD. So, we need to know rate of one currency against the other. Such rate is reflected as quote of A/B type. In our case a quote looks like EUR/USD.
A currency which is placed before “/” is called base currency and currency which is placed after “/” is called counter (quoted) currency. For any currency pair at 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 – quoted currency.
How a currency position in the quote is defined? Let’s digress from Forex and discuss separate country, for example, Japan. Historically every country has its own rules of quotes recording. Usually they are created in order it will be more convenient to provide information. It is more convenient to say that one USD may be bought or sold at 104.78 Yens than vice versa. That is why currency rate of Japanese Yen is presented as USD/JPY. The method of currency rate record, when a unit price of a foreign currency is denominated in a certain units of the national currency, is called direct quotation. The method of currency rate record, when a unit price of a national currency is denominated in a certain units of the foreign currency, is called indirect quotation. In our case – USD/JPY – is a direct quotation for Japan.
There is no such a concept as national currency at Forex and the main reserve currency is US Dollar. For quotes with US Dollar the rules of currency rates record, formed in the appropriate countries, are used. The concept of direct and indirect quote is used towards USD. With some currencies USD is a base currency and it is called indirect quote. With other currencies USD is 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 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 to US Dollar.
We may conclude that one EURO sells/buys for 1.2845 US Dollars, one US Dollar sells/buys for 97.5 JPY Yens and so on.
It is important to know that in some lists of quotations in the Internet the authors do not emphasize direct and indirect quotations and it is implied that the user is informed and understands which currency in the quote is a basic one. For example, you may find a quote JPY/USD 97.50, here indirect quote against USD is meant – USD/JPY 97.50. Sometimes quotations against USD are denoted by one currency, for example JPY 97.50. That is why it is important to teach quotation pairs which you are going to use in trading and know what quotation (direct or indirect) it is appear to be against USD. Otherwise you may take incorrect decision regarding deal execution. For instance, CHF which is always quoted currency in the pair with USD. A quote CHF 1.1623 means that one USD buys/sells for 1.1623 CHF and not vice versa.
It is also important to understand how quotations are changing. Your main aim at 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 USD, for example GBP/USD the increase of a quote means the rise of GBP and the fall of USD. For indirect quote against USD, for example USD/JPY the increase of the quote means the rise of USD and the fall of JPY. That is why it is so important not to confuse the quote type against interesting for you currency when you close a deal at Forex.
For different quotations different accuracy value (the number of digits after decimal point) is used. Minimal quotation value change is called a pip and for different quotations 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. It is worth mentioning that big figures are changing rather slowly with the course of time.
The price of one pip denominated in USD is of particular interest. If take direct quotes against USD it is not a problem because a pip is already denominated in USD. In case with indirect quotes against USD one pip volume in USD is necessary to calculate according to the special formula. We will discuss it later when begin to learn how to calculate profit and loss.
In this chapter all quotations were denominated 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.