How to Read Forex Pairs: Bid, Ask, Pips & Spreads

The foreign exchange market, commonly known as forex, involves the global trading of currencies. Understanding how to read currency pairs is fundamental for anyone participating in this market, whether for international business, travel, or investment. Currency exchange rates are dynamic, reflecting the relative value of one currency against another. This article aims to clarify the essential components of currency pair quotations, demystifying the numbers and specialized terms that define currency movements and trading costs.

Decoding the Currency Pair Structure

Currency trading always involves two currencies, presented as a pair. This structure indicates the relative value of one currency unit compared to another within the foreign exchange market. The first currency listed in the pair is referred to as the “base currency,” while the second currency is known as the “quote currency” or “counter currency.” This arrangement signifies how much of the quote currency is needed to equal one unit of the base currency.

For instance, in the EUR/USD currency pair, EUR (Euro) is the base currency, and USD (United States Dollar) is the quote currency. A quotation of EUR/USD 1.0850 means that one Euro can be exchanged for 1.0850 US Dollars.

Common examples of currency pairs illustrate this concept, such as USD/JPY (US Dollar vs. Japanese Yen) or GBP/USD (British Pound vs. US Dollar). In USD/JPY, the US Dollar is the base currency, and the Japanese Yen is the quote currency. This indicates how many Japanese Yen are required to purchase one US Dollar. Similarly, for GBP/USD, one British Pound’s value is expressed in US Dollars.

Interpreting Bid, Ask, and the Spread

Currency pairs are quoted with two distinct prices: the Bid price and the Ask price. These two prices are fundamental to understanding the cost of trading and how brokers operate within the forex market. The Bid price represents the rate at which a broker is willing to buy the base currency from you. Conversely, the Ask price, sometimes called the Offer price, is the rate at which the broker is willing to sell the base currency to you. The Ask price is consistently higher than the Bid price.

The difference between the Ask price and the Bid price is known as the “spread.” This spread constitutes the transaction cost or the broker’s profit margin. For example, if EUR/USD is quoted as 1.1234 (Bid) / 1.1236 (Ask), the Bid price is 1.1234, and the Ask price is 1.1236.

In the EUR/USD example (1.1234/1.1236), the spread is 0.0002. This difference is measured in pips, which will be discussed further. The magnitude of the spread can indicate market liquidity; a tighter spread suggests higher liquidity and lower trading costs, while a wider spread may reflect lower liquidity or increased market volatility. Major currency pairs often have tighter spreads due to high trading volumes.

Understanding Price Movements with Pips and Pipettes

Price movements in the forex market are measured using units called pips and, for precision, pipettes. A pip represents the smallest standard unit of price change in a currency pair. For most currency pairs, a pip is a one-digit change in the fourth decimal place. For example, if the EUR/USD pair moves from 1.1050 to 1.1051, that is a one-pip increase.

There is a notable exception to this rule for currency pairs involving the Japanese Yen (JPY). In JPY pairs, such as USD/JPY, a pip is a one-digit change in the second decimal place. For instance, if USD/JPY moves from 145.20 to 145.21, this is a one-pip change. Pips are important for quantifying gains or losses in trading, as the value of a pip depends on the currency pair and the size of the trade.

To provide even finer precision in price quoting, especially with advancements in trading technology, “pipettes” (also known as fractional pips or points) are used. A pipette is one-tenth of a pip. For most currency pairs, pipettes are the fifth decimal place, while for JPY pairs, they are the third decimal place. For instance, if EUR/USD moves from 1.12345 to 1.12346, that is a one-pipette movement. Understanding pips and pipettes is essential for assessing price changes and calculating their monetary impact on a trading position.