Forex Basics for the Clueless

In CNN or BBC, we hear a lot of jargon about how the Dollar is appreciating against the Euro or the Yen. As simple folks, how does this fit in into our lives? Can we actually make money from learning how the foreign exchange works? The answer is a resounding yes!

However, it would be suicide if one suddenly plays in the forex market without understanding the basics. It may seem a little tricky and confusing at first but once you get the hang of it, you'd find yourself easing your way into the business.

First and foremost, how do you read exchange rates (XR)? The first currency shown is the base currency and the value of the second currency is relative to that of the base currency. USD is usually the base currency in the forex market except for the British pound (GBP), the Australian dollar (AUD) and the Euro (EUR). To illustrate, a quote of USD/PHP 46.01 means that 1 USD=46.01 PHP, or your one US dollar can already buy 46.01 Philippine peso. Reading exchange rates for GBP, AUD and EUR works the other way around. A EUR/USD 1.3434 XR means 1 EUR=1.3434 USD or your one Euro can already buy 1.3434 US dollars.

My economics is a little rusty, you say. What does appreciating and depreciating mean?

Appreciation and depreciation of a currency is always in relation to another currency. This is basically referring to the movements in the exchange rates. When the XR goes up where the US dollar is the base currency, this just means that the dollar strengthened or appreciated while the other currency has weakened or depreciated. Conversely, when the XR goes down, the dollar depreciated while the other currency appreciated. To show you an example, if the USD/PHP quote goes up from 46.01 to 48.01, this means that the peso depreciated while the USD appreciated because a dollar can now buy 2 more pesos than before.

Simply put, if the exchange rate goes higher, that value of the base currency appreciates. Logically, if it goes lower, the base currency depreciates.

In forex trading, you would often hear a two-sided quote: 'bid' and 'ask'. The 'bid' is the selling price of the base currency while simultaneously buying the counter currency. "Ask" is simply the opposite of "bid" which is the buying price of the base currency.

It is also important to be familiar with the term pips, or the spread or margin a trader is applying to the transaction. Pip actually means "percentage in point" and refers to the difference of the fourth decimal point in the bid/ask price. For example, in USD/PHP XR, a 3 pip spread is quoted as 46.2500/46.2503. Exception would be the JPY where the quotation is only taken out to two decimal points. To earn a profit, traders would buy low and sell high of the base currency. In the example shown above, the 3 pip spread would already represent the trader's margin.

You have just been presented with the basics of the forex market. Timing is everything when playing in the forex market---knowing the best time to buy or sell your dollars. Forex, to some extent, is kind of gambling because of the risks involved. Prices are very volatile. You may have sold your dollar today at a very low price and the next day, exchange rates shoot up. Lack of information can just cause you your hard-earned money. It would truly help if one is abreast with the current global and political issues and the movements of oil prices, among other things, because these definitely have influence on currency prices. Players should always keep an open and alert mind because prices can change at a blink of an eye. One should be responsible in protecting their money by being aware of everything that's going on around them, not just in the neighborhood but ultimately, in the bigger realm things.

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