Every forex trade comes down to a single question: will this currency get stronger than that one? Almost everything else is detail. Once three ideas settle into place, the pair, the pip and the spread, the numbers on your screen stop looking random and start telling you something useful. This lesson covers all three.
01 A currency pair is one thing priced in another
You never buy a currency on its own. You trade it against something else, which is why every forex price arrives as a pair. The first currency is the base, the thing you are actually buying or selling. The second is the quote, which is simply the money you measure it in.
When you see EUR/USD at 1.0850, one euro is worth 1.0850 US dollars. If you think the euro will strengthen against the US dollar, you buy the pair. If you think the opposite, you sell it. A rising price means the base currency has gained ground, and that one rule explains most of what a chart is telling you.
02 A pip is the market's normal unit of movement
Prices rarely move in big round jumps. They tick along in small increments. For most pairs, one pip is a move in the fourth decimal place. Brokers usually show one extra digit after that, the fifth decimal, called a pipette or fractional pip. A pipette is just a tenth of a pip, used for slightly finer pricing.
It's worth getting comfortable with pips early, because they are the unit you'll use to describe nearly everything you do. How far away your stop sits, how much you stand to make, how much you are putting at risk. A line like "I risked twenty pips to make sixty" is the plain language behind every trading plan you'll ever write.
03 The spread is what it costs to get in
At any given moment there isn't one price, there are two. The bid is the price you can sell at. The ask is the price you can buy at. The small gap between them is the spread, and it goes to your broker. You pay it the instant you open a trade, which is why a brand new position usually shows a tiny loss before the market has moved at all.
Say you buy one mini lot of EUR/USD, which is 10,000 units, at an ask of 1.0851. On this pair a single pip is worth about one US dollar per mini lot. A two pip spread means you start the trade roughly two US dollars down, and the price has to climb two pips just to bring you back to level. That is why active traders care so much about tight spreads. Place twenty trades in a day and a one pip saving on each adds up fast.
A "commission free" account is not the same as a free one. Most of the time the cost is simply moved into a wider spread instead. When you compare brokers, look at what a trade actually costs you all in, the spread together with any commission, rather than the headline.
- In GBP/JPY, which currency is the base?
- The price moves from 1.2540 to 1.2546. How many pips is that?
- The bid is 1.0849 and the ask is 1.0852. What is the spread?
Show answers
1) GBP, the currency named first. 2) Six pips. 3) Three pips.
- A pair prices the base currency in terms of the quote currency. Buy when you expect the base to strengthen.
- A pip is the fourth decimal place, and it is the unit you'll measure profit and risk in.
- The spread is the gap between bid and ask. It is your cost to enter, so a tighter spread is a cheaper trade.
Further reading: Euro foreign exchange reference rates, published every working day by the European Central Bank, a good place to read real quotes.
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