On a recent trip to the Hashemite Kingdom of Jordan, I met
the Jordanian Dinar (JOD).
It turns out, American dollars (USD) don’t go as far as I thought in that part of the Middle East.
At the time, for every Dinar, I had to fork a dollar and 40 cents.
Another way to put it?
Does this look familiar? It’s a Forex quote. The first currency is the one you buy (base currency). The second currency is the one you sell (quote or counter currency).
-By the way, this currency pair isn't very popular (if it's even available) with online FX brokers.
So if you see EUR/USD 1.06, you know it means: a euro for 1.06 dollars.
Can you sell the pair EUR/USD and get your 1.06 dollars per euro back?
Back in Jordan, the exchange at the airport asked me for 1.4 USD for every JOD. This was their ask price.
The ask price is the exchange rate at which the broker is willing to sell currency to you. If you want to buy, you have to check the ask price.
But there is another price every broker quotes.
At the end of my trip, I wondered how many dollars I could get from exchanging some leftover dinars. I wasn’t surprised to see a lower quote, say 1.35, since I don’t recall the exact bid quote.
This bid price is the exchange rate at which a broker is willing to buy currency from you. If you want to sell, you have to do it for the bid price.
The bid price is always lower than the ask price. That is how brokers make money, they buy at a low price and sell at a high price. The difference between these prices is called the spread.
Wait… if I become a Forex trader and start trading frequently, won’t I always lose money? After all, my broker has control over both bid and ask prices and I will always have to buy high and sell low. Won’t I?
While it’s true that the broker’s spread won’t ever be zero, competition from other brokers and dealers make it so the spread is kept reasonable. After all, why would anyone trade with a broker who charges more than others?
Also, unlike in the stock market, brokers in the forex markets do not make a commission on each trade you make. Their revenue comes from the spread between ask and bid prices.
And finally, even the least volatile currency pairs tend to move around 30 pips in a day. This gives you enough room to profit since spreads are much lower.
What is a pip? A pip (point in percentage) is a hundredth of a cent in a currency pair, usually the fourth decimal place or the second in the case of a pair with the Japanese yen.
EUR/USD Bid 1.0414 Ask 1.0417
As you can see, the broker’s spread is 3 pips. The difference between the bid price and the ask price.
So what should you look for in a Forex broker?
We go into more detail here but the first criteria must be reliability and integrity. It has to be a broker with a good reputation.
But assuming every scammer gets thrown out of the forex broker market what else should I look for?
You probably have an idea of how much money you are willing to invest as a beginner.
I suggest starting with a demo account.
Depending on your money management rules and the size of your initial investment, you will have to decide on one of the following types of accounts:
Regular: this is the type of account more expert traders use. The minimum trading lot size is 100,000 units.
Mini: the minimum lot size is 10,000 units.
Micro: this is the smallest type of account. The minimum lot size is 1,000 units of currency.
The differences between these are mainly the size of the initial deposit (regular requires more) and the lot sizes you will be trading.
Make sure your broker offers the type of account that best serves your needs.
My suggestion is to jump into Forex risk management first. It’s the best follow-up piece.
But you may also jump into some of the currency pages:
Or into other interesting topics such as
See you there,
The Forex Economist
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