Chapter 5. Forex Currency Quotes

When we buy goods in a store, the price tag on the goods reflects the cost of the goods in units of national currency. And we have no questions if we are going to buy a book with a price of 100 rubles – we take the book, prepare 100 rubles and go to the cash register.

At Forex, one currency is always traded relative to another currency, so a simple price tag is not enough here. Suppose we are dealing with the US dollar and the Euro. To estimate the value of the currencies, we need to know the value of one US dollar expressed in Euros or the value of Euros expressed in US dollars. That is, we need to know the exchange rate of one currency against the other. This exchange rate is reflected by the A/B quote. In our case with Euro and US dollar, the quote looks like EUR/USD.

The currency that stands before the “/” sign is called the base currency, and the currency that stands after the “/” sign is called the counter or quoted currency. For any pair of currencies on Forex, the position of the currency in the quote is strictly defined. For a pair of Euro and US dollar it looks exactly as EUR/USD, and never appears as USD/EUR in the official quotation lists. Thus, EUR is the base currency, and USD is the quoted currency.

What determines the position of the currency in the quote? Let’s take our attention away from Forex for a while and consider a separate country, for example, Japan. Each country has historically developed its own rules for recording exchange rates for each foreign currency. Such recording rules are explained, as a rule, only by the convenience of information presentation. It is more convenient to say that one U.S. dollar can be bought or sold for 104.78 Japanese Yen than to say that one Japanese Yen can be bought or sold for 0.0095 U.S. dollar. That is why the exchange rate of the Japanese Yen against the U.S. dollar is represented by the USD/JPY quote, not the other way around. The way of recording the exchange rate, when the value of a unit of foreign currency is expressed through a certain number of units of national currency is called a direct quote. The way of recording the exchange rate, in which the value of a unit of national currency is expressed through a certain number of units of foreign currency is called a reverse quote. In our example USD/JPY is a direct quote for Japan.

Since there is no concept of national currency at Forex, and the main reserve world currency is the U.S. dollar, to denote quotations with the U.S. dollar are used the rules for recording exchange rates established in the corresponding countries. The concepts of forward and reverse quotes at Forex are used in relation to the U.S. dollar. With some currency pairs, the U.S. dollar will be the base currency of the quote and the quote will be inverse. With some pairs of currencies, the U.S. dollar will be the quoted currency and the quote will be direct. For example, in a pairing with the Japanese Yen (USD/JPY), the US dollar is the base currency in a reverse quote, and in a pairing with the British Pound Sterling (GBP/USD), the US dollar is the quoted currency in a direct quote.

When we say that the A/B quote is X, we mean that one unit of the base currency A can be bought or sold for X units of the quoted currency B. In our example with the Euro and the US dollar, if we say that the EUR/USD quote is 1.2845, we mean that one Euro can be bought or sold for 1.2845 US dollars. In other words, buy/sell transactions always refer to the base currency of the quote. The table shows examples of Forex quotes against the US dollar.

From the table we can conclude that one Euro is sold/bought for 1.2845 US Dollar, one US Dollar is sold/bought for 97.50 Japanese Yen, etc.

 

It is important to know that some online quote lists do not emphasize the forward/reverse quote and assume that the user is knowledgeable, understanding which currency in the quote is the base currency. For example, on the Internet you may see a quote written as JPY/USD 97.50, when in fact it is the reverse quote against the US dollar, i.e. USD/JPY 97.50. Sometimes quotes against the US dollar are denoted by just one currency, e.g. JPY 97.50. Therefore, it is very important to learn the pairs of quotes that you are going to use in your work on Forex and to know which quote (forward or reverse) it is in relation to the U.S. dollar, i.e. it is necessary to know the base of the quote in the pair! Otherwise, you can mistakenly make a diametrically opposite decision to buy/sell. This is especially true for the Swiss franc (CHF), which is always a quoted currency in a pair with the U.S. dollar. That is, a CHF 1.1623 entry means that one US dollar is sold/bought for 1.1623 Swiss francs, not vice versa.

In addition to understanding the quotes themselves, it is very important to understand the direction of change of quotes. After all, our main goal in working on Forex is, as in any transaction, to buy cheaper and sell more expensive. For direct and reverse quotes the direction of change of rates have opposite values. For a direct quote against the U.S. dollar, for example GBP/USD, an increase in the quote means an increase in the price of the British pound sterling and a decrease in the price of the U.S. dollar, because one pound sterling can now be bought/sold for more U.S. dollars. And for a reverse quote against the U.S. dollar, for example USD/JPY, an increase in the quote means appreciation of the U.S. dollar and cheapening of the Japanese Yen, because one U.S. dollar can now be bought/sold for more Japanese Yen. That is why it is important not to confuse the type of quotation in relation to the currency of interest when making a Forex transaction. This principle is shown in the figure, which represents simplified charts of changes in quotes.

In the table above you can see that different quotes have different accuracy of their value (different number of digits after the decimal point). The minimum change in the quote value is called a point (point, pip) and it is different for different quotes. For example, for EUR/USD quote one point is equal to 0.0001, and for USD/JPY quote one point is equal to 0.01. It should be noted that the big figures of the quote (big figure) usually change quite slowly over time.

Of great interest is the value of one pip expressed in US dollars. In cases of direct quotes against the U.S. dollar, this is not a problem because the pip is already expressed in U.S. dollars. In the case of reverse quotes against the US dollar, the value of one pip in US dollars must be calculated using a special formula, which will be discussed later, when we will learn how to calculate the profit/loss of a trade.

In this chapter, all quotes were expressed in spot (current) prices. We intentionally did not complicate the material of the chapter by introducing the concepts of buy price, sell price, spread value and cross rates. These concepts will be discussed in the following chapters.