One of the most difficult things for most people to understand about foreign currency exchange (aka “forex“) is how to read the quotes. We know that when we see a stock trading for $11.25 a share, it means we can use $11.25 of our U.S. dollars to buy one share. But what the heck does USD/JPY 116.09/13 mean? This article will explain.
The first thing to understand is that a forex trade is the exchange of one currency for another. Normally, we buy goods with our currency — the U.S. dollar. But on the forex, we can use U.S. dollars to buy other currencies — the Japanese yen (JPY), the Euro (EUR), the Canadian dollar (CAD), and many more — and we can use those currencies to buy U.S. dollars.
A currency-pair quote of USD/CAD 1.2000/05 means there is a $1.2000 CAD bid price and a $1.2005 CAD ask price for the U.S. dollar-Canadian dollar currency pair. In other words, you can obtain $1.20 Canadian for every $1 USD (bid price), or, alternatively, you have to pay $1.2005 Canadian for every $1 USD.
If you’ve ever visited Canada (or any other foreign country), you’re familiar with this two-way exchange rate! The difference between the bid and the ask is known as the spread – in this case, it is five pips.
Base Currency and Counter Currency
In the examples above, the U.S. dollar is the base currency. The base currency always comes first, and the counter currency is always expressed in terms of how many units equal one unit of the base currency. In the example above, the U.S. dollar is the base currency, and it always is except when being compared to the “Queen’s currencies” (the Great Britain pound, the Australian dollar, and the New Zealand dollar), and the Euro.
For example, the Euro-U.S. dollar currency pair is represented as EUR/USD. If the exchange rate is EUR/USD 1.3645/49, this means that you can obtain $1.3645 American for one Euro; or, alternatively, you can obtain one Euro for $1.3649. In this case, the spread of four pips.
Inverting the Pairings
You can, if you choose, invert the pairings by dividing 1 by the counter currency. For example, if one U.S. dollar equals $1.20 Canadian, then how much does one Canadian dollar equal in U.S. dollars? 1/$1.20, or 83 1/3 cents. Conversely, if one Euro equals (approximately) $1.36, then one dollar equals 0.735 Euros (1/$1.36).
For more about forex trading, I highly recommend Investopedia’s Forex Market Tutorial (pdf). X-Rates.com is another great site for checking out current foreign-exchange rates. For a comprehesive Forex trading course, this review of the Hector Trader system may be worth checking out.