 Currency trading is always done with currency pairs traditionally noted XXX/YYY. YYY and XXX are the ISO 4217 international three-letter codes of the currency. The price of XXX currency is expressed in YYY currency. The currency pair is an instrument, which can be bought or sold.
• Buying the currency pair implies buying the first, base currency and selling (short) an equivalent amount of the second, quote currency (to pay for the base currency). (It is not necessary for the trader to own the quote currency prior to selling, as it is sold short.) A speculator buys a currency pair, if she believes the base currency will go up relative to the quote currency, or equivalently that the corresponding exchange rate will go up.
• Selling the currency pair implies selling the first, base currency (short), and buying the second, quote currency. A speculator sells a currency pair, if she believes the base currency will go down relative to the quote currency, or equivalently, that the quote currency will go up relative to the base currency.
Having bought a currency pair, the speculator will have an open position in the currency pair. Right after this operation, the position’s value will be close to zero, because the base currency’s value is approximately equal to the value of the equivalent sum of the quote currency. Actually, the value will be somewhat negative, as a result of the spread involvement.
In modern currency market, a trade has to go through three steps:
1. The trader discusses the currency pair and the quantity he’d like to trade with another trader.
2. Another dealer replies with a bid and an asks a price
3. The trader replies to the bid and asks price with one of:
a. purchase (by saying "Mine" or "I buy" or "I take")
b. sell (by saying "yours" or "I give you" or "I sell")
c. reject.
The transaction completes if the final response is a purchase or a sell. Since the dealer does not know whether the trader will buy or sell, he is to offer a "good" market price.
The market described is called a spot market and the transactions that take place in it are called spot deals.
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