We generally come across several concepts when it comes to currency trading. It's very much vital to know about these concepts before we start trading in currencies.
Base currency and Counter or Quote currency:
While quoting currency pairs, the first currency is referred to as the base currency and the second as the counter or quote currency.
A currency exchange rate is the value of a certain world currency with respect to another currency for example, Indian rupees to US dollars. That is the rate which represents how much of the quote currency is needed to get one unit of the base currency. For example, 1 USD = 44.56 INR. So, you require 44.56 INR (quote currency) to get one unit of US dollar (base currency).
Direct, Indirect and Cross Quotes/Rates:
On the currency exchange market in every country, the local currency is quoted directly or indirectly against the US Dollar and other foreign currencies.
- Direct Quote: The direct quoting is the amount of local currency needed to buy one unit of the foreign currency and the amount of home currency respectively due to be received when one unit of foreign currency is being sold i.e. 1 foreign currency unit = x home currency units
- Indirect Quote: The indirect quote is the amount of foreign currency needed to buy one unit of the home currency i.e. 1 home currency unit = x foreign currency units
- Cross Currency Quote: When a currency quote is given without the Indian Rupee as one of its components, this is called a cross currency, i.e. when home currency is not involved in the currency pair. The most common cross currency pairs are the USD/EUR, EUR/GBP, GBP/JPY, etc.
Bid and Ask:
The currency pairs are usually traded and quoted with a 'bid" and 'ask" price. The 'bid" is the price at which you are willing to buy and the 'ask" is the price at which price you are willing to sell.
For example, if the SGD/INR (Singapore Dollar vs Indian Rupee) currency pair is quoted as - SGD/INR = 36.28 and you purchase the pair, this means that for every 36.28 Indian Rupees that you sell, you get SG$1. If you sold the currency pair, you receive 36.28 Indian Rupees for every SG$1 you sell.
The quote before the slash is the bid price, and the two digits after the slash represent the ask price (only the last two digits of the full price are typically quoted). Bid price is always smaller than the ask price. Let's look at an example: SGD/INR = 36.282/86. So bid price = 36.282 and ask price = 36.286
Spreads and Pips:
A pip is the minimum incremental move a currency pair can make. Pip stands for price interest point. A move in the SGD/INR from 36.282 to 36.286 equals 4 pips. And a move in the USD/INR from 44.35 to 44.50 equals 15 pips.
The difference between the bid price and the ask price is called a spread. If we were to look at the following quote: USD/INR = 44.35/50, the spread would be 0.15 or 15 pips.
Risks inolved with currency trading
It is important to remember there are risks involved with currency trading. In the futures market the quantity traded is huge. So, what does happen is that a slight volatility in prices can lead to a heavy downslide in your capital. However, the futures market does allow investors an opportunity to trade in currency as there are restrictions on the amount of currency that you can hold in the forex markets. In India, you can trade on the MCX very freely in currencies where there is also a good opportunity.