What’s the Difference Between Direct and Indirect Exchange Rate
There are two terms which you’ll more than likely come across in everyday trading. These are Direct Exchange Rate and Indirect Exchange Rate.
You may have already heard these terms mentioned before. But, how much do you really understand about the direct and indirect exchange rate and what the difference between them? And, what do they mean for your Forex trading endeavors?
Here we work to break down these commonly used terms and explain in further detail what they mean. We also consider just how they can affect your daily trading endeavors.
An Introduction to the Direct and Indirect Exchange Rate System
First things first - the exchange rate is quoted directly and indirectly.
We call a quote direct when it expresses one unit of foreign currency price, by means of the domestic currency.
We call a quote indirect when it expresses one unit of the domestic currency, by means of the foreign currency.
Now you understand what direct and indirect exchange rates mean. Next, you need to consider what it is that makes them different from one another.
Direct Exchange Rate Explained
Known as a direct quote, this is a foreign exchange rate included in a quote of fixed units of foreign currency. This is then set against variable amounts of what we refer to as the domestic currency.
There is a formula that you can use to calculate a direct quote.
Where DQ - Direct Quote and IQ - Indirect Quote
In use, you will tend to find that the base currency employed in most direct quotes is that of the US dollar. This is simply because it is one of the most traded currencies in the world. Yet, the two major exceptions to this rule are the Euro and the British Pound.
The Three Main Base Currencies Used in the Direct Exchange Rate
The US Dollar
The US dollar is perhaps one of the most widely recognized in the trading world. Thus, it's the most active traded currency across the globe.
You may find that most of the currencies you come across quote the foreign currency units as dollars. This is especially so in trading rooms and professional publications.
This effectively means that the base currency serves here as the dollar. This is irrespective of whether the speaker happens to be in the U.S. or rather elsewhere.
There is a good example of this. Say we were discussing the trading price of the Canadian dollar. We would not say 85 US cents per Canadian dollar. The correct phrase here would instead be 1.17 Canadian per 1 US dollar.
The British Pound
Though, this is one of the major exceptions to this rule when it comes to the dollar base quote. We see this whereby we quote the British pound against other currency types. This includes here the dollar. Yet, this is except for that of the Euro.
The simple reason for this here is that it merely reflects its prior dominance as currency. In those years leading up to the second world war, the pound was, in fact, a world dominator when it came to currency. This was also the case before the U.S economy became powerful and began to dominate here.
Once again, as an example of this - the pounds exchange rate is always quoted the same. This is despite considering it direct or indirect. So, we would say $1.45 for £1, whether directly in the U.S. or indirectly in the U.K.
The Euro only come into existence as recently as 1999, January 1st to be exact. But when doing so, it replaced a vast selection of European trading currencies.
These included those such as the French Franc, the German Mark, and The Dutch Guilder – to name but a few. These were examples of some of the most major trading European currencies. But, that was before the introduction of the Euro.
The overseeing European Central Bank made a decision at this point. They decided the conversion meant that the Euros currency would be the dominant one. This would apply throughout the financial market.
It was then stated that in the future, the Euro was always going to be the base currency during trading. This included when it was in use against both the British pound and the US dollar.
So, as an example, you’ll always see that the quotes used to buy €1 are always the number of pounds or dollars.
Indirect Exchange Rates Explained
Known as an indirect quote, this is a foreign exchange market currency quotation. You'll find it used to express the foreign currency amount required. This applies to when both buying or selling the domestic currency unit.
Yet, you may also come across its other well-known term of Quantity Quotation. You'll find this phrase used because an indirect quote rate expresses quantity here. That is the quantity of foreign currency. This is what's required when buying domestic currency units.
Here, the base currency will be the domestic currency when it comes to indirect quotes. The counter currency is the foreign currency here.
Once again, the US dollar is the more dominant currency even with an indirect quote. But, the indirect exchange rate is often a little harder to understand. Thus, it pays to find a way to calculate it to make it easier to access.
An easy way to calculate using an indirect quote is this:
Other Differences Between Direct and Indirect Exchange Rate
- With a direct quote, you have to divide. With an indirect quote, however, you do the opposite and multiply.
- An indirect quote differs from a direct quote by way of its expression. This relates to one unit’s foreign currency price about its domestic currency.
- A lower exchange rate in a direct quote implies strength. Or it can indicate appreciation in the domestic currency. Whereas, in an indirect quote, it means a depreciation. Or it can mean a weakening in the domestic currency.
Currency Pairs are an Important Element of Direct and Indirect Exchange Rate
Trading Forex online is not just about currency trading for different counties. What you are effectively doing is trading currency pairs. Thus, a currency pair is also known as a quote, as we’ve referred to it above.
Thus, it’s worth continuing to familiarize yourself with the currency definitions. This will help you understand the many currency quotations that you come across. In turn, you’ll be able to immediately spot all differences. This includes those between direct and indirect exchange rate.
That is how we display the currency pair Euro to US dollars. This means that for one Euro sold, it is equal to 1.23456 US dollars.
When breaking this currency pair displayed down:
If you are about to start your Forex journey, you'll inevitably come across the terms Direct and Indirect exchange rate many times as you trade.
We believe that by utilizing the above examples and definitions, you’ll be able to spot those which are direct quotes and those which are indirect quotes with just one quick glance. The terms direct and indirect exchange rate will not be something you'll pause over but you'll be able to acquire info with confidence.