In foreign currency trading there are always currency pairs – the base currency and the counter currency. The base currency – it is in essence our product, it is denoted on the left side of the pair. We always buy or sell the base currency. The counter currency – it is the means of payment and is denoted on the right side of the pair. In a transaction involving the EUR/USD I buy or sell the Euro against the USD wherein the means of my payment is the USD.
The exchange rate is the price of one unit of the base currency in terms of the counter currency. Let's take a look at the Euro against the USD: One Euro is equal to 1.5220 USD.
Spread
Spread is the difference between the buying price and selling price and is the commission which you pay, as currency traders. For example: If, for instance, you want to convert USD to Euros at the bank. They will tell you that the buying price is 1.56 and that the selling price is 1.49. In other words, in order to buy one Euro you would have to pay a little more than one and a half USD. If in that very moment you would want to sell your one Euro to the bank, the bank will buy one Euro at a price slightly lower than one and a half USD, so if you sold 1000 USD to the bank you received 641 Euros. By selling the Euros back you will get only 955 USD. You paid 1000 USD and received 955 USD, so where are the other 45 USD? This is the profit of the CHANGE store – this is the commission they charge from their customers. This is the only commission that you will pay; in the Forex market there are no additional commissions.
NOTE: It is implied by such that we will always lose because of the spread in the first second after the trade.
Pips
Another important concept in the Forex market is “pips” – pip (singular), pips (plural) In the Forex market the exchange rate rises by pips and falls by pips. For most of the currencies, the pips are denoted 4 places after the decimal point. In other words, if the EUR/USD rate is 1.5220 then the number of the pip is 0. If the exchange rate was previously 1.5220 and now it rose by one pip, the exchange rate will be 1.5221. If the exchange rate fell by 10 pips, it would be 1.5210 and so on. The Japanese Yen is different: For the Japanese Yen the pip is denoted at two places after the decimal point, meaning that, if the USD/JPY is at 88.57, then the pip is equal to 7. if the exchange rate rises by 3 pips it would be equal to 88.60 and if it decreases by 27 pips the exchange rate would be 88.30.
Average daily fluctuation
To become acquainted with the concept, the average daily fluctuation of the EUR/USD is about 100 pips a day. On more turbulent days the fluctuation reaches 200-300 pips, on calmer days the fluctuation reaches 50-60 pips. And in terms of percentage? If the exchange rate is currently 1.5220 and I want to announce tomorrow that it rose by one percent, it would be represented by a rise of 152 pips. So if we said that the daily fluctuation of the EUR/USD is about 100 pips a day, by what percent does the EUR/USD fluctuate on average? About 0.7%-0.8%. and in more turbulent periods – 2% at most. Fromthiswecan learnof anewand important advantage that exists in the Forex market – this market is stable, and I'm referring mainly to the major currencies: Euro, USD, Pound, Yen and Swiss Franc. This is a stable market, with exchange rate fluctuations of half a percent up to one and a half percent throughout the day. There is no possibility that you will trade a currency and lose 10%-15% in one day.
Value of pips
Let's now learn the value of every pipwithin the confines of a particular transaction. If the exchange rate of the EUR/USD is 1.5220 and you want to buy 100,000 Euros, how many USD do you have to pay? 152,200 USD, of course. A second passes and the exchange rate rises to 1.5221. By howmany pips did the exchange rate rise? By one pip. And what is the current value of the 100,000 Euros? 152,210 USD. Which is 10 USD more. The value of one pip in a transaction of 10,000 Euros is one USD. In other words: In a transaction of 100,000 Euros, each pip has a value of 10 USD. And in a transaction of one million Euros – 100 USD.
How are pips calculated?
We take the amount of the transaction that we have performed in terms of the base currency and divide by 10,000 – this is the value of one pip in terms of the counter currency.
For example: For a transaction of 100,000 Euros we divide by 10,000, and we get 10. This means that the value of every pip is $10. If we execute a transaction of 30,000 Euros, every pip worth is 3 USD. For the Japanese Yen the calculation is slightly different. We divide the amount of the transaction in terms of the base currency by 100 and that is the value of the pip.
For example: A transaction of 100,000 USD in the currency pair USD/JPY, we divide by 100 and the result is 1,000 Yen. Assuming that the exchange rate is 88.00, we divide the 1,000 by 88, meaning, 11.36 USD per pip.
Example: We will take the currency pair of EUR/GBP and a transaction of 100,000 Euros, each pip is worth 100,000 divided by 10,000 and is therefore worth 10 USD. And in what currency are we paying in? In Pounds. Meaning that every pip is equal to 10 Pounds.
Size of the spreads
Do you know what the accepted ask/bid spread is for the EUR/USD exchange rate? 3 pips. So in order to perform a transaction of 100,000 Euros, which is equal to 152,000 USD how much commission must one pay?
If every pip is equal to 10 USD in a transaction of 100,000 Euros, and the spread is 3 pips, we will pay 30 USD in commission – a onetime payment which includes the purchase and the sale.
Commissions If to compare the commissions rate paid in the stocks market we will notice that in the Forex market the commissions rate are very low.
For example, in a 10,000 Euro trade the stock's commission is half a percent hence 50 Euro. In Forex however you will pay only 3 USD commission for a 10,000 Euro trade, for a 100,000 Euro trade you will pay only 30 USD commission and so on and so forth.
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