There really isn't any substitute for climbing that tremendously slippery slope called The Learning Curve. If you learn the basics, and take in as much forex trading information as you possibly can, you'll save yourself a fortune. You can just jump straight in, as I did, but eventually you'll still have to climb the dreaded learning curve anyway. It will be a tad easier - but only because your pockets are empty! So learn to trade the forex markets first - not last! This forex newcomer's article teaches currency pairs and spreads, and is for the complete forex beginner.



To make that easy online money (allegedly), we trade a currency by buying it at one price and re-selling it later at a different price - exactly as though wheeling and dealing in timber or gold. If we have traded wisely, that second transaction will leave us with a profit which is the difference between the buying and selling prices. The complication is that at any instant, there are two prices to contend with depending on whether we are buying or selling. A further complication is that any currency has many different prices, depending on what other currency it is being compared with.

A currency exchange rate is always quoted as a currency pair. For example, the EUR/USD refers to the Euro currency Euro (European currency) and its rate against the U.S. Dollar. The first currency in the pair is the base currency, while the second is the quote currency. The EUR/USD exchange rate indicates how many US Dollars a buyer will need to pay to buy one Euro, or conversely how many US Dollars he will be receive when selling one Euro.

In basic terms, an exchange rate is most often presented as a pair of numbers, one of which is the bid price and the second the ask price (for example: 0.8325/29). The ask price is what will be paid when buying a currency, it represents the amount that will be paid in the quote currency to obtain a single unit of the other or base currency. The bid price is paid when selling a currency and is what will be obtained in the quote currency if selling a single unit of the base currency.

The bid price will always be lower than the ask price. In currency markets, a simple abbreviation for the exchange rate pair is used, as in the example above (eg: 0.8325/29). The first figure (before the slash) is the bid price (what you would receive in dollars if you sell euros). The second component (after the slash) is the ask price (what you would pay in USD if you want to buy euros).

The ask price is commonly obtained by removing the final two digits from the first constituent of the number (the bid) and replacing them with the second constituent. For instance, in my example, the ask price is 0.8329. For a second example, 0.8199/02 means a bid price of 0.8199 and (since the ask price is always higher, here we need to amend the second digit up by one as well), so that the price will then become 0.8203. In some currency pairs it is usual to quote rates in units of 100 rather than ten, and this is the case in particular with USD/JPY (the US dollar against the Yen).

These small units (each 1/10 of a basis point or 1/100 with the yen) are called PIPS by traders the world over. So looking at my the examples above, the difference between buy and sell prices (the Bid and the Ask) are 4 pips and 3 pips (for the second). The difference between bid and the ask prices is widely referred to as the spread. The spread is effectively the charge made to you by the broker or spread-better to handle your trade.

For very popular currency pairs like the GBP/USD (UK pound sterling against the dollar), the spread can be as low as three pips when using a spread-betting service. If you buy into a currency with a 3-point spread, and you are betting (say) 10 dollars a pip, then you immediately show a loss of 30 dollars in your account, and the market would have to rise 4 pips (40 dollars) before a profit would be achieved. The spread is therefore a proportional charge - the more money you trade per pip, the more you pay in fees.

This fixed spread does have a major benefit however, in that if you trade long periods where a rise of 100-plus pips is conceivable in a single trade, you will still only pay that initial 3-pip spread, which is only a tiny proportion of your profits. Compare this to the poor day-trader who often makes several trades per day and in each trade looks for profits in single percentage figures (say 9 or 10 pips per trade). For him, even a tiny 3-pip spread is an effective 30% tax on his earnings!

Forex trading newcomer should therefore search out the best, most competitive rate (lowest spread) they can find, especially if they are planning to start out with very small trades (say around a couple of dollars per pip). If they are starting small, they are far less likely to be penalised financially if they use a large online broker or spread-better who will be more keen to obtain their future business. Traditional brokers (even many of those with an online service) will charge a bigger spread for small trades because their own costs (overheads) are higher.

I would also advise Forex newcomers to trade only the four most popular currency pairs (Dollar/Swiss Franc. Pound/Dollar, Euro/Dollar, Dollar/Yen), where they will usually obtain the lowest costs (by spread), and where the liquidity and volatility of these markets will usually make profitable trades easier to find.