It’s crucial to understand the fundamentals of forex trading, from currency pairs to pips and earnings, before opening an account.
A currency pair uses a ratio to compare the values of two different currencies. The basic currency, which is always one, is the very first one. The quote currency, which is the second unit of money, shows how much one can be exchanged for. A quote of “EUR/USD 1.23000” indicates that one Euro is equivalent to $1.23.
Each ratio is given in two to five decimal places and is also available in a flipped-over form that results in a new currency pair that moves the other way. To continue with our example, USD/EUR compares the value of the U.S. dollar to the euro, whereas EUR/USD compares the value of the euro to the U.S. dollar.
EUR/USD = 1.25000/1.00 = 1.25000
USD/EUR will then equal 1.00/1.25000, or.80000.
Before the popularity of the forex soared earlier this decade, traders from many nations would take long and short positions with their home currency at the bottom (the quotation currency). Today, the currency pair with the biggest volume is traded by the majority of participants worldwide. The most popular version is probably going to have a smaller bid/ask spread, which will reduce trading expenses.
When the ratio rises, forex traders profit from holding long EUR/USD bets; when it falls, they lose money. In contrast, traders profit from shorting the EUR/USD when the ratio declines and lose money when it rises. Despite the fact that brokers may provide dozens of currency pairs, four significant pairs generate the most trading interest:
the euro and the dollar (EUR/USD)
the U.S. dollar and the Japanese yen, or USD/JPY
GBP/USD stands for the British pound sterling and the US dollar.
the U.S. dollar and the Swiss franc (USD/CHF)
Pips and Earnings
Two ratios are shown in forex quotes: a greater asking price and a lower bid price. The lowest price increase, known as a pip, and the last two decimals are frequently printed in very large print (percentage in point). The number of pip gained or lost after the position is closed is used to determine profits and losses. Because traders must purchase at the asking price and sell at the bid price, with the spread being the difference between the two values, all positions begin with a tiny loss.
This is standard practice since the majority of forex brokers don’t charge commissions or other costs for transaction execution and instead rely on the bid/ask spread as their primary revenue source. The spreads between major and minor currency pairings are normally less than those between minor currency pairs, but many brokers now provide set spreads, which prevent them from expanding and contracting in response to market conditions, even if it’s to your advantage.
For their forex positions, traders must select the lot sizes. The smallest trade size for the currency pair is called a lot. When trading the U.S. dollar, $100,000 is regarded as a typical 100k lot, and it once served as the minimum amount permitted by many forex firms. Mini lots, which come in increments of 10,000 units ($10,000 when trading USD), and micro lots, which come in increments of 1,000 units ($1,000 when trading USD), have modified this.
The amount of pip required to turn a profit or incur a loss decreases with increasing unit size. The following example, in which both trades make the same profit, demonstrates how this operates.
A typical EUR/USD pip equals.00001.
When you purchase $100,000 in EUR/USD at 1.23000 and sell it at 1.23001, you “gain” 1 pip.
(1 pip = (0.00001/1.23000) x 100,000 = $8.10 per pip)
When you purchase $10,000 EUR/USD at 1.23000 and sell it at 1.23010, you “make” 10 pips ($81 cents per pip x 10 pips) = $8.10 profit.
Of course, the knife is double-edged because losing a long or short trade with a large unit size will happen faster than losing a transaction with a small unit size.
As a result, it’s critical to thoroughly research your new endeavor before investing real money in it. You should also establish risk-management abilities, such as the proper position sizing, holding times, and stop loss strategies. On the Internet, there are many free pip calculators that might be of great use.