What is an exchange rate?

I am having hard times understanding the fundamentals. Sorry if I am opening so many topics.

My question is, is the exchange rate the bid price or the ask price?

I thought it was the ask price because it shows how many units of the base currency units I can buy with the quote currency, but I know I can also calculate (by using the exchange rate) how many units of the quote currency I can buy with the base currency too.

Can I ask what the exchange rate really is and how it is calculated (if it’s the average of some other variables etc.)?

1 Like

The exchange rate states the number of units of the counter currency you would receive if you handed over 1 unit of the base currency. For example, the Euro / US Dollar exchange rate or EUR/USD - EUR is the base currency. If you handed over 1 Euro to a bank, today’s exchange rate says that you would receive about 1.0866 US dollars.

Our brokers actually charge us a bit more than 1.0866 to buy EUR/USD - that is their “ask price”. And they give us a bit less than 1.0866 when we sell EUR/USD - that is their “bid price”.

The difference between the bid and the ask prices is the spread.

Most charts are set by default to show only the bid price.

The exchange rate is found by trades between the big banks and currency dealers. Its supply and demand - more supply than demand makes the rate fall, more demand than supply makes the rate rise. Our brokers use the forex market’s exchange rates to calculate their own quoted bid and ask prices.

3 Likes

Thank you very much.

One more connected question please. So my account currency is SGD (Singapore dollars) and when I buy EURUSD, the used margin for this trade is shown in SGD. Is it correct to think this way,

  1. When I buy EUROUSD, my broker first converts my margin into USD based on USDSGD ask price
  2. My broker calculates and locks up the required margin (in USD) based on the leverage and the amount of lots
  3. Then the broker converts the margin amount back into SGD at the USDSGD bid price and reflects it on my trading platform in SGD

So is it correct to say there is not a single exchange rate that the broker uses for the above conversions?

We’re not buying and selling currency. We are betting that the exchange rate will either rise or fall.

1 Like

Ok sorry maybe I am using the wrong terminology. What I mean when I buy a currency I mean placing a buy order on the platform. So are the steps I wrote above about the conversions done between my account’s base currency and the currency pair I am ‘betting on’ correct to assume?

No, the broker doesn’t convert any money into any other currency.

Its like you sit in Singapore and you place a bet on a boxing match in Paris between a French fighter and a US fighter. The bet is in Singapore and nobody in Paris knows anything about your bet. Your bet is not transported to Paris. And no matter how big your bet (your position, your trade) this will not affect how the boxers perform.

But if you picked the right boxer and he wins, you get SGD from your broker.

Thank you for the clarification.

Let’s say I am going long 1 lot on EURUSD and the leverage is 20:1. I want to calculate the margin requirement in my account currency (SGD) manually. If I am not wrong this is how I would calculate;

‘Required margin in SGD’ = 100,000 x (EUR/USD) x (USD/SGD) x (5/100)

I assume USD/SGD in the equation above is the ask price of the broker.

Then let’s say I closed the position at a price (in EURUSD) that is 100 pips above where I opened it. Now I want to manually calculate my profit in SGD without relying on what the platform/broker shows me.

‘Profit in SGD’ = 100,000 x 0.0100 x (EUR/USD) x (USD/SGD)

I assume here USD/SGD ratio is the broker’s current bid price.

So every time I open and close a position in a currency pair that is different than my account currency I lose money to spread. Am I right?

If I am right, then I am losing money to spread twice, because I am already paying the spread for EURUSD anyway.

But my main confusion is about the exchange rate. Exchange rate is represented by one single number but there are two numbers, the bid and the ask to use for conversions. When we say exchange rate, do we take the average of the bid and the ask to end up with a single number to call it ‘the exchange rate’?

Thank you.

I admit I know nothing about lots. I am in the UK so I can spreadbet forex. There’s no such thing as lots in spreadbetting so I can’t help on this one, sorry.

In reality there is not one unique exchange rate. There are quotes for people who want to trade a pair, with two prices, bid and ask - bid to sell and ask to buy. There are no conversions, it doesn’t matter what currency your account is in.

This is from Oanda.

I don’t know if I am misunderstanding it. But does it not mean that when I open a position involving a different currency pair than my account currency, there will be conversion charges?

No. This condition applies if for example you live in Singapore and so your home currency is SGD, but you open an account in USD. You have the option to do this with many brokers. It has nothing to do with the currencies in the pairs you’re trading.

An exchange rate is the value of one currency in relation to another currency. It represents the amount of the second currency that can be exchanged for one unit of the first currency. Forex exchange rates are calculated based on the supply and demand for a specific currency. The exchange rate is determined by the market forces of supply and demand for a specific currency pair.

I can find the definition of exchange rate online I am asking about the nature of it. I will just stop asking deep questions I guess.

Like honestly, when you first started learning about forex didn’t you ask yourself the same questions, like if speculators are only trading CFDs how do they affect the price movement? if CFD is only a bet between me and my broker then how come it is beneficial for big players if I get stopped out (if that really happens which doesn’t really matter) If I had trillions of dollars and buy CFDs I would affect the market right, but hey I am not buying or selling any currency I am just playing a betting game with my dealer so how CFDs affect the real actual currency prices. I am a Physics teacher, when I ask students what is Newton’s second law they will tell me F=ma, then I ask them to derive the conservation of momentum from newton’s law, they will all look at me as if I am a ghost. Conservation of momentum and newtons second law are exact same things but are written in different forms for curriculum/pedagogy purposes.

I think CFDs are a lot more complicated than just betting on a currency pair, or all you say is wrong and we do buy and sell real actual currency pairs online just without receiving the actual physical money, otherwise really nothing taught in Pipsology makes sense

I can’t say anything about pipsology. But I know we are not in the business of buying and selling currency.

There are many confusing things in forex and I was utterly confused when I started, but that’s normal. As the old joke goes, “If you’re not confused, its because you don’t understand what’s happening”. Some of the confusion is generated by the industry because they want clients to think they are buying and selling some asset which has an intrinsic value: they do not want clients to think that they are simply betting on the value of the assets.

So for example if you thought the value of Van Gogh paintings was going to rise, you could buy some Van Gogh paintings. Or you could sign a Van Gogh long CFD from an art gallery, under which they agree to pay you money if the value goes up and you agree to pay them money if it goes down. Except it wouldn’t be an art gallery, it would be a broker. And CFD stands for Contract For Difference. And you would never own a Van Gogh.

Exchange rate is vacillating on a daily basis based on which the market is moving. So keep your eyes on the exchange rate.

A country’s currency is valued in terms of another currency at an exchange rate. Or to put it another way, it shows how many units of a foreign currency a customer can purchase with one unit of their own currency.
Example
Jane is a trader in the currency department of a large, international bank. Every day, she places trades in dozens of currencies in fantastic , foreign requests. still, to conduct her day- to- day liabilities, she needs to be apprehensive of major rates similar as the USD to GBP, or the USD to Euro. moment, she has to place one complicated trade convert$,000 to the GBP, and also the Euro for a customer who wants to transfer money between banks. First, Jane must know the rate for the currencies involved.

After conducting thorough exploration, she finds 1 USD is equal to0.75 GBP, and 1 GBP is equal to 2 Euros. Her transformations using each rate is as follows$,000 is changed for 750 GBP, also the 750 GBP is changed for 1500 Euros. Jane has fulfilled her customer’s order, and successfully used currency rates to facilitate the inflow of capital throughout the world.

Exchange rate is changing as currencies are changing hands on a regular basis. And we are trading based on this exchange rate.

1 Like

The rate at which one currency is exchnaged for another is known as exchnage rate. It vassilates at times.

1 Like