Exchange Rate Quotations, Direct & Indirect Rates, Spread & Spread

Forex quotations can be quite complex for the average person. It takes some training and knowledge to understand that these quotations can be provided in more than one way! Also, it takes a little getting used to before a person can quickly comprehend these quotes and take quick decisions based on the same. In this article, we will explain the two types of Forex quotations as well as the abbreviations which are used in them.

Nomenclature

Any Foreign exchange market quotation always uses the abbreviation of the currency under question. There are standard currency keys or currency codes that have been created by International Standards Organization (ISO). These keys are used for transactions worldwide.

The key is made up of 3 alphabets. The first two alphabets of the key denote the country to which the currency belongs whereas the third alphabet of the key is the first alphabet of the currency. Hence, United States dollar is referred to as the USD, Indian Rupee is referred to as INR, Great Britain Pound is referred to as GBP and the Japanese Yen is abbreviated as JPY.

The exceptions to this rule would be currencies like Euro which is abbreviated as EUR and most importantly the Swiss Franc which is abbreviated as CHF.

Direct Quotation

Under this method, the quote is expressed in terms of domestic currency. This means that the rate expresses how one unit of domestic currency relates to the foreign currency. Therefore, if unit of the domestic currency were to be exchanged, how many units of the foreign currency would it beget? This method is also alternatively referred to as the price quotation method.

Therefore, if the value of the domestic currency increases, a smaller amount of it would have to be exchanged. Conversely a decline in value would create a situation where a large amount of the domestic currency would have to be exchanged. Hence, it can be said that the quotation rate has an inverse relationship with the value of the domestic currency.

The value of the domestic currency is assumed to be 1 in case of a direct quotation. The price being quoted explains the number of units of foreign currency that can be exchanged for a single unit of domestic currency.

Example: An example of direct quotation would be

USD/JPY: 113.15/18

This quote suggests that roughly 113.15 units of Japanese Yen can be exchanged for 1 unit of United States Dollar. The two rates provided are bid and ask rates i.e. the different rates at which the market maker is willing to buy and sell the currency.

Usage: The direct quote method is one of the most widely used quotation methods across the world. This is the norm for quoting Forex prices and is assumed de facto until another method has been explicitly mentioned.

Indirect Quotation

This method is the opposite of the direct quotation method. Under this method, the quote is expressed in terms of foreign currency. Therefore this rate assumes one unit of foreign currency. It then expresses how many units of domestic currency are required to obtain a single unit of a foreign currency. Sometimes this quote is also expressed in terms of 100 units of foreign currency. This method is often referred to as the quantity quotation method.

Since this method is quoted in terms of foreign currency, the quoted rate has a direct correlation with the domestic rate. If the quote goes up, so does the value of the domestic currency and vice versa.

Example: An example of indirect quotation would be:

EUR/USD: 1.275/79

In this case, the first currency i.e. EUR is the domestic currency. Therefore, the indirect quote refers to approximately 0.875 EUR being exchanged for 1 unit of USD. Once again the two rates provided are the bid ask rate i.e. the two different rates at which market makers are willing to buy and sell the currency.

Usage: The usage of indirect currency quotation is extremely rare. It is only in the Commonwealth countries like United Kingdom and Australia that the indirect quotation method is used as a result of convention.

Direct Quote and Indirect Quote

The direct quote and indirect quote can be expressed in relation to each other, as follows:

Direct Quote = 1 / Indirect Quote

Spread & Spread

In forex trading, the spread is the difference between the bid (sell) price and the ask (buy) price of a currency pair. There are always two prices given in a currency pair, the bid and the ask price. The bid price is the price at which you can sell the base currency, whereas the ask price is the price you would use to buy the base currency.

The base currency is shown on the left of the currency pair, and the variable, quote or counter currency, on the right. The pairing tells you how much of the variable currency equals one unit of the base currency. The buy price quoted will always be higher than the sell price quoted, with the underlying market price being somewhere in-between.

There are two types of spreads:

• Fixed
• Variable (also known as “floating”)

Fixed spreads are usually offered by brokers that operate as a market maker or “dealing desk” model while variable spreads are offered by brokers operating a “non-dealing desk” model.

Advantages

Fixed spreads have smaller capital requirements, so trading with fixed spreads offers a cheaper alternative for traders who don’t have a lot of money to start trading with.

Trading with fixed spreads also makes calculating transaction costs more predictable. Since spreads never change, you’re always sure of what you can expect to pay when you open a trade.

Disadvantages

Requotes can occur frequently when trading with fixed spreads since pricing is coming from just one source (your broker).

There will be times when the forex market is volatile and prices are rapidly changing. Since spreads are fixed, the broker won’t be able to widen the spread to adjust for current market conditions.

So if you try to enter a trade at a specific price, the broker will “block” the trade and ask you to accept a new price. You will be “re-quoted” with a new price.

The requote message will appear on your trading platform letting you know that price has moved and asks you whether or not you are willing to accept that price. It’s almost always a price that is worse than the one you ordered.

Slippage is another problem. When prices are moving fast, the broker is unable to consistently maintain a fixed spread and the price that you finally end up after entering a trade will be totally different than the intended entry price.

Slippage is similar to when you swipe right on Tinder and agree to meet up with that hot gal or guy for coffee and realize the actual person in front of you looks nothing like the photo.