Most new investors in the forex market are usually confused with the way currency prices are quoted. In this section, we'll take a look at currency quotations and see how they work in currency pair trades.
Reading a Quote
When you look at a currency quote, you'll notice that all currencies are quoted in a pair – for example, USD/CAD or USD/JPY. The reason that currencies are quoted as a pair is because when you buy a currency you are selling a different one as well. A sample forex quote for the U.S. dollar (USD) and Japanese yen (JPY) would look like this:
This is the standard format for a currency pair. In this example, the currency to the left of the slash (USD) is referred to as the base currency, and the currency on the right (JPY) is called the quote or counter currency. This is important to remember. The base currency (in this case, the U.S. dollar) is always equal to one unit (in this case, US$1), and the quoted currency (in this case, the Japanese yen) is what that one base unit (USD) is equivalent to in the other currency (JPY).
This sample quote shows that if you wanted to buy US$1, you would have to pay 119.50 yen. Or if you wanted to sell US$1, you would receive 119.50 yen. If instead of USD/JPY, this quote read USD/CAD = 1.20, you would read it the exact same way. If you want to buy US$1, it will cost you C$1.20, and if you wanted to sell US$1, you would get C$1.20. These exchange rates simply tell you how much you will pay/receive if you buy/sell the "base" currency.
When you are buying the base currency (because maybe you think the base currency's value will go up) and selling the quote currency, you are entering into a long position. If you instead sell the base currency and buy the quote currency, you are going into a short position. So again, looking at the USD/JPY example, if you buy the USD, you're going long; if you sell the USD, you are going short.
Bid and Ask
Like buying a stock in the stock market, when trading currency pairs, the forex quote will have a bid price and an ask price. The bid and ask prices are always quoted in relation to the base currency.
When selling the base currency, the bid price is the price the dealer is willing to pay to buy the base currency from you. Simply put, it's the price you'll receive if you sell.
When buying the base currency, the ask price is the price at which the dealer is willing to sell you the base currency in exchange for the quote currency. Simply, when you want to buy a base currency, the ask price is the price you're going to pay.
A typical currency quote can be seen below. The number before the slash (1.2000) is the bid price, and the two digits after the slash (05) represent the ask price (1.2005) - only the last two digits of the full price are usually quoted. The bid price will always be lower than ask price. This is how the dealers make their money; they buy low and sell for a little bit higher. (For more, read Common Questions About Currency Trading.)
USD/CAD = 1.2000/05
Bid = 1.2000
If you wanted to buy the USD/CAD currency pair, you would be buying the base currency (U.S. dollars) in exchange for the quote currency (Canadian dollars). You need to look at the ask price to see how much (in Canadian dollars) the market is currently charging for U.S. dollars. According to this quote, you will have to pay C$1.2005 to buy US$1.
More On Quotes
To sell this USD/CAD currency pair, or sell the USD in other words, you need to look at the bid price to see how much you are going to get. Looking at the bid price in this quote, it tells us you will receive C$1.2000 if you sell US$1.