Currency Quotes
Currency Symbols
Virtually every country, with some small exceptions, has its own currency, and most
of them can be traded. However, the currencies of a few countries are the most actively
traded, and constitute, by far, the largest volume of trades. The big 5 are the
United States dollar (USD), Euro (EUR), Japanese yen
(JPY), the British pound (GBP), and the Swiss franc
(CHF).
Each currency is symbolized using a 3-letter ISO (International
Organization for Standardization) code: the 1st 2 letters designate
the country, the 3rd designates the currency. The most famous illustration
of this is for the United States dollar—USD. Other countries that call their
currency dollars include the Canadian dollar (CAD), the Australian dollar
(AUD), and the New Zealand dollar (NZD). As you can see, each of this
symbols ends in "D", which designates the dollar name.
However, sometimes the country name or currency that is symbolized is not the most
common name. Thus, the symbol for the Swiss franc is CHF, where CH
stands for Confederation Helvetica, which refers to Switzerland, and MXN
stands for the Mexican Nuevo Peso, even though the most common name for Mexico’s
currency is simply the peso.
Currency Quotes
One of the purposes of money is as an accepted form of barter. Money is desired
not so much for the thing itself, but what it can be exchanged for. Thus, in virtually
every transaction, money constitutes one side of the transaction. Thus, money is
exchanged for a car, for groceries, for services, and so on. Because money is the
universal barter, everything else is measured in terms of it. For instance, I can
buy a loaf of bread for $2 and a car for $20,000. Both prices are expressed as the
amount of money that would have to be given in exchange for the item.
However, there is an equivalent way of thinking about these transactions that allows
a better understanding of currency exchanges. Buying a loaf of bread for 2 dollars
is the same as selling 2 dollars for a loaf of bread. In other words, it is nothing
more than an exchange. Money is the medium of exchange, and so, everything is priced
in terms of money.
But when you buy currency, then both items exchanged are money. When you are looking
at currency quotes, it is important to understand the format of the quote.
Currency is always quoted in pairs. The 1st quote is for the base currency,
and is a unit of that currency. The 2nd currency is the quote currency
(aka counter currency), which is the amount of the currency equal to a unit
of the base currency.
Base Currency/Quote Currency = Exchange Rate
Example: If GBP/USD = 2, then it takes 2 U.S. dollars to buy 1 British pound.
Quote Currency/Base Currency = 1/(Base Currency/Quote Currency)
Example: If GBP/USD = 2, then USD/GBP = 1/2 = 0.5; thus, 1 USD can be exchanged
for 1/2 GBP.
Thus, a quote for GBP/USD is the number of United States dollars (USD) needed to
buy 1 Great Britain pound (GBP), or how much USD would be received for 1 GBP.
Pips
When you buy something in a store in the United States, the smallest unit of price
is 1 cent. This is because the coin with the least value is the penny, and so it
would not be possible to sell or buy something for less than that, if only a single
item is purchased, as is usually the case. Thus, a grocery store can’t sell a loaf
of bread for $2.001, because there would not be any way for the customer to give
the grocer 1/10 of a cent, since there is no coin for that. The only way that the
grocer can actually get $2.001 per loaf of bread is to require that the customer
buy at least 10 loafs of bread for $20.01. But the customer is not likely to buy
so many loaves of bread, so the grocer can’t sell the bread for $2.001.
However, because the quote currency is valued as a unit of the base currency,
which makes it easier to compare different currency values and changes in currency
values, and because a large amount of currency is usually traded, a smaller unit
of measure is convenient in expressing currency prices. This smaller unit is called
a pip, which is equal to .0001 of the base currency, for most currencies.
In U.S. dollars, it is equal to 1/100 of a cent. Thus, 10,000 pips = 1 dollar. A
well known exception to the value of a pip is the Japanese yen. Because the yen
has much less value than the United States dollar, a pip is considered to be only
1% of the yen. (Currently, 120 yen ≈ $1.) Thus, most currency quotes are expressed
by 4 significant digits, and the Japanese yen is expressed to 2 significant digits.
The pip is the smallest value quoted by brokers and dealers. (Sometimes
you will see quotes in the news that have 5 or 6 significant digits. These quotes
were probably transacted by banks for large amounts of currency, but the smallest
quote given by almost all forex brokers is the pip.)
Bid/Ask Quotes
Most investors buy currencies from market makers, or dealers, in that currency,
but are commonly referred to as brokers. A dealer makes money by buying at one price
and selling a little higher. When the dealer sells, the trader is buying, and when
the dealer buys, then the trader is selling. The trader pays the broker's ask price (aka offer price), and the trader
sells to the broker for the broker's bid price, and the difference between
the prices is called the spread, which in currencies, is usually at least
4 pips. The bid price for the trader is always lower than the ask price, because
that’s how forex dealers make money. If you want to buy currency, you have to pay
the higher ask price, but if you want to sell currency, you have to sell it at the
lower bid price. So if you were to buy currency, then immediately sell it back to
the same dealer, the dealer would make money, and you would lose money. Thus, the
spread is the transaction cost of trading currency.
For major currencies, the spread is usually about 3 to 5 pips or more, depending
on the dealer. For less frequently traded currencies, or for major currencies during
high volatility or low volume, the spread can be much greater. Although many brokers
advertise 2-pip spreads, you will rarely see spreads less than 4 pips.
The actual transaction cost is determined not only by the spread, but also by the
lot sizes of currency trades. Most regular accounts trade in lots of 100,000 units,
and so a pip is worth 10 units of currency. Most mini-accounts trade in lot sizes
of 10,000 units, and so a pip is worth 1 unit of currency. If the quote currency
is the USD, then a lot size in a regular account is $100,000 and each pip difference
is $10. For a mini-account, a pip would be equal to $1. If the quote currency is
other than USD, then the pip value would have to be converted if you wanted to know
what your profit or loss in USD. Since there are 10,000 pips to each unit of currency,
and most lot sizes are either 100K or 10K, the total pip value can be found by the
following formula:
Total Pip Value = Lot Size/10,000 x Conversion Rate
When the quote currency is the trader's native currency, then there is no need
to multiply by the conversion rate for that currency.
Quote Convention
The quote convention in forex is based on the fact that there are 2 quotes for any
currency, the bid quote and the ask quote, both of which are expressed as a unit
of the base currency. The symbols show the currency pair, and the numbers list the
bid/ask quote for the quote currency (thus the name!).
Base Currency/Quote Currency Bid/Ask
The bid price is usually expressed to 4 significant digits after the decimal point,
which represents the number of pips. The ask price is usually expressed as the significant
digits that are different in pips from the bid price. For instance, you may see
a quote such as the following:
EUR/USD 1.3522/24
This means that if you wanted to sell Euros for dollars, you would get $13,522.00 for 10,000 Euros, but if you wanted to buy Euros with
U.S. dollars, then you would have to pay $13,524.00 to buy
10,000 Euros.
This quotation is expressed in terms of the dollar, but if the quote currency is
the Euro, then it would be quoted this way:
USD/EUR 0.7395/400
This is equivalent to the above quoted price, but it is expressed in Euros per dollar
rather than dollars per Euro. You can find the equivalent quote by dividing 1 by
the quote. Thus, 1/1.3522 = 0.7395 (rounded) and 1/1.3524 = .7400.
Converting it back: 1/0.7395 = 1.3522. Note that rounding errors makes the round
trip conversion inexact, but you get the idea.
Cross Currency Quotes
Any currency can be traded for any other currency. Cross currency quotes
lists each currency in terms of the other currencies. Here is an example of key
cross quotes of 4 major currencies:
|
Key Cross Rates for 5/14/2007. (Source: MarketWatch.com)
|
|
Currency
|
USD
|
GBP
|
EUR
|
JPY
|
|
USD
|
|
0.50443
|
0.73951
|
120.10500
|
|
GBP
|
1.98244
|
|
1.46603
|
238.10043
|
|
EUR
|
1.35225
|
0.68211
|
|
162.41160
|
|
JPY
|
0.83260
|
0.41999
|
0.61572
|
|
You can see from this table that the quote for GBP/USD = 1.98244
and the obverse quote, USD/GBP = 0.50443. Note that
the 1st column is the base currency while the 2nd row is the quote currency.
New Developments
Fractional Pip Pricing
9/25/2007 - FXCM has introduced fractional pip pricing for their major currency
pairs. So instead of seeing a quote of EUR/USD 1.401/04, you may see a quote
such as EUR/USD 1.04014/038. While, theoretically, this should yield some
savings to the forex trader, it may be more a marketing gimmick than anything else.
It would be very difficult to tell if there were any real savings, because the average
spread could be just as wide as before, except that you would be subtracting
5 digits instead of 4. Example: 1.44235-1.41235=1.4423-1.4123=3 pips. And even though
there will be many differences of fractional pips, that does not mean that the average
is better than before.
Fractional pip pricing would be most powerful on an organized exchange where the
best bid/ask prices from all market participants are displayed, and would certainly
result in narrower spreads. However, there is yet no organized exchange for currency.
While FXCM advertises a No Dealing Desk, where quotes from forex traders is shown
to a number of participating banks, I don't know how well this works. Someone
would have to do a statistical analysis of spreads displayed by FXCM and competing
forex dealers, and see if it results in narrower spreads.
For forex dealers, marketing is the name of the game, and certainly fractional pip
pricing does sound good. Of course, 1 or 2 pip spreads that are widely advertised
by forex dealers sound good, too. I have used FXCM, and they provide a very good
service, but I rarely saw 2 pip spreads, even on major currency pairs such as EUR/USD.
It's one thing to advertise such spreads, and another to actually see them and
trade them.