When you deal in the forex market, you deal in currency pairs. You cannot buy an individual currency. Instead you buy units of currency pairs.
If you go to any forex trading site, say forex.com you will see currency pairs like GBP/USD, EUR/USD, USD/JPY and so on. In a currency pair, the first currency is the base currency, and the second currency is the quote currency. Let's try and understand the concept with some more examples.
|Currency Pair||Base Currency||Quote Currency|
On the trading sites, you will see an exchange rate or price listed against each currency pair.
|Currency Pair||Exchange Rate|
* Prices as of November 2014
The exchange rates indicate the amount of quote currency needed to buy the base currency. So to buy 1 USD, you need 0.6329 GBP or 1.1337 CAD or 0.8086 EUR or 1.1698 AUD.
When you purchase a currency pair, you are buying the base currency and selling the quote currency. So if you are buying 1 unit of USD/GBP you are buying 1 USD by giving 0.6329 GBP. Similarly, if you are buying 1 unit of the USD/CAD pair you are buying 1 USD by giving 1.1337 CAD.
Think of it like any other transaction where you are paying some money to buy a product or a commodity. Here you are paying GBP or CAD or EUR to buy USD.
Example 1: You have 10 units of USD/GBP at an exchange rate of 0.6329. If tomorrow there's some positive news in the US market and USD becomes stronger in compared to GBP. The price of the USD/GBP pair will increase. That's because now you will need more GBP to buy 1 USD as USD is more in demand due to the positive news. Suppose the exchange rate increases to 0.6454, you can sell off your 10 units at a profit.
Example 2: You have 15 units of USD/CAD at an exchange rate of 1.1337 each. If Canada reports positive economic growth and the demand for CAD goes up, your USD is now less valuable against the CAD. If the price of this pair comes down to 1.1245 each, you will be at a loss.
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