Unlike stocks and futures that trade through exchanges or the NASDAQ, Forex trading is done through market makers that include major banks as well as small to large brokerage firms located around the world who collectively make a market on a 24/7 basis. The Forex market is always “open” and is the largest financial network in the world (daily average turnover of trillions of dollars). Forex trading involves trading currency pairs such as the EUR/USD pair (Eurodollar/US dollar pair) where a buyer of this pair would actually be buying the Eurodollar and simultaneously selling short the US dollar.

The format of a Forex pair is YYY/ZZZ, where the first currency is called the “base” currency and the second currency is called the “counter” currency. The price for a Forex pair is expressed in terms of the counter currency. For example, the price of the EUR/USD pair is expressed in US dollars (the counter currency) as 1.3667. This means that the base currency, the Eurodollar in this case, equals US$ 1.3667. The price of the USD/JPY pair is expressed in Japanese Yen as 108.02, because for this pair the Japanese Yen is the counter currency. This means that the base currency, the US dollar in this case, equals 108.02 Japanese Yen.

Prices are expressed in pips, which are nothing more than the minimum increment that a currency pair price can change. For example, if the EUR/USD price changes from 1.3790 to 1.3791, the price is said to have gone up by 1 pip. Most major pairs are priced to 4 decimals which is the equivalent of 1/100th of one percent. The exception would be the Japanese Yen pair that only trades to 2 decimals. This is because there are usually over 100 yen to the dollar. Forex pair quotes are on a bid-ask basis. The bid is the price that the market is willing to pay a seller at a point in time for a specific currency pair. The ask is the price that the market is willing to sell to a buyer at a point in time for a specific currency pair. The difference between the bid and the ask is called the bid/ask spread. For example, a typical EUR/USD quote could be 1.3784 bid 1.3787 ask which is a spread of 3 pips. Since the spread is how the market makers are compensated, there is no commission when placing a trade.

Also, it is important to note that the spread will vary depending on market conditions. So the quote itself for any given Forex pair is the bid-ask combination at a point in time based on the market driven floating exchange rate. The quotation lists the bid price first, then the ask price. For the EUR/USD example above, the quote would be expressed simply as 1.3784/1.3787 or 1.3784/87.

Trading is done in lots, either 100,000 unit standard or 10,000 unit mini lots. For example, for a standard lot purchase, if the EUR/USD quote was 1.3784/1.3787, then buying an EUR/USD pair means buying 100,000 Euro dollars and selling short $137,870 US dollars. Therefore, for a standard lot in which the USD is the counter currency, 1 pip will equal $10 ($1 for a mini lot). For other major counter currency pairs 1 pip will range from $8 to $10.

Forex dealers offer leverage as high as 100:1 and sometimes higher. At 100:1 leverage, 1 standard lot pair in which the USD in the base currency would require $1,000 in margin ($100,000/100). On the other hand, a 1 mini lot pair would require only $100 in margin ($10,000/100). If the account value falls below the margin requirement, the dealer will close out the trade automatically.