Forex
The largest market by volume, and the only one where every instrument is a ratio of two things that both move.
11 min read · beginner · lesson 1 of 6
What this covers
- Read a currency pair as a ratio rather than a price
- Calculate what one pip is worth on a given pair and size
- Identify what moves a currency over days and over months
- Account for the cost of holding a position past the daily rollover
- Recognise where a currency is managed rather than freely floating
What you are trading
A currency pair is a ratio. EUR/USD at 1.09 means one euro exchanges for 1.09 dollars. Buying the pair is buying euros with dollars; selling it is the reverse.
This has a consequence that catches people arriving from equities: there is no long-only side. Every position is long one currency and short another at the same time, so a pair can rise because the base strengthened, because the quote weakened, or both. A move in EUR/USD says nothing on its own about which of the two did the work.
Separating the two requires looking at each currency against several others. A currency that is rising against everything is strong; one that is rising against a single counterpart is not.
Reading a quote
- Base currency
- The first currency in the pair. In EUR/USD it is the euro. The quoted number is how much of the quote currency one unit of the base is worth.
- Quote currency
- The second currency, and the one your profit or loss is denominated in before conversion back to the account currency.
- Pip
- The standard increment of movement. On most pairs it is the fourth decimal place, 0.0001. On yen-quoted pairs it is the second, 0.01. This exception is not cosmetic and gets its own section below.
- Lot
- The unit of position size. A standard lot is 100,000 units of the base currency, a mini lot 10,000, a micro lot 1,000.
What a pip is worth
IllustrativeAll figures are illustrative.
Pip value is the pip size multiplied by the position size, expressed in the quote currency.
EUR/USD, one standard lot: 0.0001 x 100,000 = 10 dollars per pip. Because the quote currency is already the dollar, this stays at 10 regardless of where the rate is.
USD/JPY, one standard lot: 0.01 x 100,000 = 1,000 yen per pip. That is not 10 dollars. At a rate near 157 it is roughly 6.40 dollars, and it changes as the rate changes.
Two separate errors follow from this, and they are not equally costly.
Using the wrong pip value mis-sizes the position. Applying 10 dollars per pip to a yen pair, where it is closer to 6.40, produces a position roughly a third smaller than intended. Wrong, but conservative.
Using the wrong pip size mis-measures the distance, and that one is dangerous. Treating a yen pair's pip as 0.0001 rather than 0.01 reads a 50-pip stop as 5,000 pips, a factor of 100. A stop placed on that arithmetic sits nowhere near where it was intended.
Compute both per pair, every time.
What moves a currency
- Interest rate differentials
- Capital moves toward higher yields. The gap between two countries' policy rates, and the expected path of that gap, is the dominant medium-term driver.
- Central bank policy
- Rate decisions and the language around them reprice the expected path. The statement usually moves more than the decision.
- Trade and capital flows
- Persistent surpluses and deficits create structural buying or selling that runs for years underneath the shorter-term moves.
- Risk appetite
- Under stress capital concentrates in a handful of currencies regardless of yield. Correlations that held for months break in a session.
Majors and crosses
| Majors | Crosses |
|---|---|
| One side is the US dollar. | Neither side is the US dollar. |
| Tightest spreads, deepest books. | Wider spreads, thinner books. |
| Positioning is published for the currency directly. | Positioning is constructed from the two component legs. |
| Moves are frequently a dollar story. | Moves isolate one currency against another. |
The cost of holding overnight
A position held past the daily rollover is settled and reopened, and the interest rate difference between the two currencies is paid or received. Holding the higher-yielding currency earns; holding the lower-yielding one costs.
On a short-term position this is negligible. On a position held for weeks it is not, and a strategy with a thin edge can be turned negative by the accrual alone.
Taking the position specifically to collect the differential is the carry trade. It works while the pair is stable or moving in favour, and it has a characteristic failure: the differential accrues slowly and the unwind is fast. Months of accrual are erased in days when positioning reverses, because everyone holding the same trade for the same reason exits at the same time.
Check the rollover figures on any pair you intend to hold. They are published by the broker and they differ by pair and by direction.
Continuous, but not uniform
The market runs from Sunday evening to Friday evening without a close, which is often mistaken for uniform conditions. It is not.
Activity concentrates when the London and New York sessions overlap. Spreads are tightest and fills cleanest in that window. Outside it, the same instrument has wider spreads and moves further on less volume.
Pairs are not equally active in every session either. Yen pairs make up a larger share of activity while Tokyo is open, European crosses during London hours, even though absolute volume peaks in the overlap for almost everything. A pair traded outside its own active session moves on thinner participation.
There is also no single exchange. Prices come from a network of banks and brokers, so quotes differ slightly between venues and there is no consolidated volume figure of the kind equities publish.
Not every currency floats freely
Some central banks act directly in the market to move their own currency, and some maintain a peg or a floor. A managed currency can sit in a narrow band for months and then move violently when the policy changes.
In 2015 a central bank removed a currency floor without prior warning. The pair moved roughly 30 percent within minutes, stops filled far beyond their levels, and accounts went negative.
This is a position sizing consideration, not a stop placement one. No stop survives that. Check whether a currency is managed before treating its calm as low risk, because a narrow range in a managed currency is the policy holding, not the market agreeing.
What PecuDesk covers
27 pairs: the 7 majors and 20 crosses, read continuously across timeframes.
Gold and the major index instruments sit alongside them and are covered in the next lesson.
Key takeaways
- A pair is a ratio. Every position is long one currency and short another.
- Pip value differs by pair. Yen pairs use 0.01, not 0.0001, and their pip value moves with the rate.
- Rate differentials and the expected path of policy dominate the medium term.
- Holding past rollover pays or costs the interest differential. Carry accrues slowly and unwinds fast.
- Continuous trading does not mean uniform conditions. Liquidity concentrates in the session overlap.
- A managed currency's calm is the policy holding, not the market agreeing.
Common mistakes
- Carrying pip size or pip value from one pair to another. On yen pairs the size error misreads stop distance by a factor of 100.
- Reading a pair's move as a statement about the base currency alone.
- Holding a position for weeks without checking what the rollover costs.
- Trading thin hours, or a pair outside its active session, at full size.
Knowledge check
OptionalRelated
- Indices and commoditiesAsset Classes
- Position sizing and risk per tradeMarket Foundations