Now you already know that the Forex trade involves buying one currency type and selling the other. Actually, whenever you trade, you simultaneously buy one currency while selling the other. Now here are terms that you should know to understand how exactly the trade is carried out.
Basic Forex Market Terminologies
In the Forex language, currencies are always quoted in pairs. For example, you will see something like EUR/USD or USD/JPY. The first currency in the quote, that is the one to the left of the slash (“/”), is called the based currency. So, in the quote EUR/USD, the Euro is the base currency. The other one is called the quote currency or the counter currency. In the EUR/USD case, the US Dollar is the quote currency.
When a trade is placed involving a given pair, the base currency of that pair is usually the basis of the buying or selling. What that means is simply that if you are buying EUR/USD, you will buy Euros while selling US dollars at the same time. If you are selling EUR/USD, then you sell Euros while buying US Dollars at the same time.
While buying or selling, the exchange rate determines how many units of the quote currency you will receive or must give away for one unit of the base currency. For example, if the exchange rate stands at EUR/USD=1.51, it means that if you buy EUR/USD, you will receive one Euro for every 1.51 US dollars you give away. If you sell EUR/USD, you will receive 1.51 US dollars for every one Euro that you give away. So how do you make a profit?
Actual Buying And Selling
The basic idea in Forex trading is very similar to what happens in the stock market. You exchange one currency type for another in the hope that the currency type you bought will increase in value against the type you sold. Let us take a typical example using our EUR/USD pair.
You anticipate that the Euro will gain value in the near future, so you buy 100,000 Euros at the exchange rate of EUR/USD=1.51. That means you spend 151,000 US Dollars. After some time, the value of the Euro indeed goes up and the exchange rate now becomes EUR/USD=1.5155. It is time to sell your Euros! At the new exchange rate, selling 100,000 Euros will earn you 151,550 US Dollars. That is a profit of $550.
In the above case, you make a profit due to the appreciation of the Euro. If you expect that the Euro will depreciate, you can also make a profit from that by selling the pair now and buying it after the depreciation.