Understanding the basics of Forex!

Commonly referred to as FX in short, the forex market is by far the largest in the world with
over trade worth $ 4 Trillion on an average day. Simply stated this implies exchange of
currencies of foreign countries with the purpose of trading. In India there are three aspects of
Forex starting with the RBI which is the overall regulator, the bank to bank or inter bank
trading and bank to customer or merchant rate transaction trading of foreign exchange. An
interesting fact about Forex is that it cannot be dome at the individual level and all
transactions have to be dome through a bank only. With these facts as premises this article
will discuss some of the basic elements of Forex trading.

All communication in Forex trading is done from the bank point of view. If a
customer wants to buy a certain amount of USDs, then instead of referring to it as the
customer wants to buy, it is always said as the bank wants to sell.
The two market rates referred to in Forex are the Bid and Ask. Bid is the rate at which
the foreign exchange is bought and Ask is the selling rate of the same.
Conventionally the market if Forex buys at a lower rate of the exchange and sells at a
higher rate. Assuming that 1USD = 55.50 INR this implies that the bid is Rs. 55.50
and the Ask maybe a higher figure like Rs. 56.00
Quotes in Forex are two types Direct and Indirect.
The direct quite is the pricing of a certain number of units of currency of home
country as against one unit of the foreign currency. For example Rs. 55.50 for 1$. In
the UK this can be 0.19 Sterling Pounds = 1$ since the home currency there is pound
sterling. In an indirect quote the opposite happens. In this case the quote is for number
of units of foreign currency against one unit of home currency. For example Rs. 1 =
1/56 th of $.

Conventionally the direct quote is referred to as American and the indirect quote is
referred to as European across the globe.
Spread in Forex is the difference between the Bid and Ask value of currency at that
time. For example if the Bid is 1$ = Rs 55 and the Ask is 1$ = Rs 60 then the spread
at that time is Rs. 5. As an indicator of the market a lower spread indicates a stable
market as compared to a higher spread.
Cross rate in Forex refers to indirect relationship between two currencies. For
example if quotes are 1USD = Rs 55 and 1 Euro = Rs 80 then this is a cross rate
between USD and Euro.
In Forex the exchange rate can be based on Spot market or Future market. Spot
market implies that the settlement will be made on the second working day after the
transaction. Future market implies that the rates will be fixed for a future date. Thus if
a bank fixes a particular exchange rate for a day in near future but the prices change,
the bank will still have to buy at those rates and face the losses. The same is
applicable for individual bidders in the Forex markets.
The appreciation and depreciation formulas referred to in the Forex simply mean the
change in value of a particular currency against another one over a period of time
typically calculated for a year.
For example if USD/INR ratio has moved from 45 to 54 in a year then the
depreciation for INR is calculated and the appreciation of USD is calculated. For

direct quotes (Forward Rate Spot rate)/Spot rate x 12 Months gives appreciation or
depreciation rates for that year. But in case of indirect quotes the formula used is
(Spot Rate Forward Rate)/ Forward rate x 12 months is used to calculate
appreciation or depreciation.

Swap Points in Forex refers to the difference between Forward rate and the prevailing
Spot Rate.

These are some of the more often used terms in Forex which are useful in getting the
preliminary idea about this sphere of trading. Forex trading is an arena worth exploring for
people who have the inclination and interest in gaining maximum from their investments.
However Forex trading has its own share of risks which must be understood prior to
investing. With a little study and research the Forex trading can be mastered by any one with
basic knowledge of finances and markets.