10 Forex Terms Every Trader Should Know
If you are new to the world of forex trading, you might have noticed some terminology which you don’t quite understand, or would like a better definition of. There’s a lot to learn, and it would be impossible to cover everything in one article, but these are some of the most important and frequently used terms to know.
This refers to the borrowing of money from a broker in order to invest in trades. The high leverage ratios available to forex traders allows for even a small initial investment to make significant profits. Of course, this comes with the risk of losing large sums too, which is why all traders must work out a robust risk management strategy before they begin.
Many brokers offer instant forex funding with leverage ratios as high as 100:1, allowing a trader to work with far higher amounts of money than their trading account holds.
When you are trading on leverage, ‘margin’ refers to the amount of money your broker requires you have in your trading account when opening a position. This money serves as a deposit which can be used by the broker. The size of the margin is related to the leverage ratio you are trading with.
Margin is expressed as a percentage of the position size. For example, your broker requires a 1% margin, and you are trading with a 100:1 leverage. You open a position size of $100,000, so you will need to have $1000 in your account, as a deposit or margin. The margin varies between brokers, and can be anything from 10% to 0.25%.
The forex market is a decentralised global market, where all the world’s currencies are traded against each other. Currencies are quoted against each other in value, and are always traded in pairs. The exchange rate refers to the relative price of two currencies, and is in a constant state of flux.
It is this fluctuation in value between currencies which forex traders aim to interpret, and base their trading decision on in order to make a profit. This can be done by selling in currencies which have risen in value, or through buying in currencies which you expect to rise in value.
Any type of currency can be traded, but it is advisable for beginners to stick to the currencies of the world’s major economies (referred to as ‘majors’), because they tend to be less volatile that those from emerging economies (referred to as ‘exotics’). It is much easier to find buyers and sellers for major currencies than other kinds.
Major currency pairs
The majors always include the US dollar, because this is the largest and most traded currency in the world. All currencies are identified in forex trading by a three letter code. For example, the Us dollar is USD, and the Euro is EUR.
The base currency refers to the first listed currency in the pair, and the quote currency is the second listed. This allows the trader to see how much of the quote currency is required to purchase the base currency.
The other major economies include the (EUR), the Japanese Yen (JPY), the Swiss Franc (CHF), the Australian dollar (AUD), the British pound (GBP), the New Zealand dollar (NZD) and the Canadian dollar (CAD).
Minor currency pairs or ‘crosses’
The minor currency pairs, which are also referred to as crosses, means that the currency pair does not include the USD, but both currencies are from the other major economies. An example of a minor is GBP/EURO, or CHF/NZD.
They are not traded in as great volume as the majors, but they still provide good trading opportunities for the experienced trader. The most frequently traded minors include the EUR, the JPY, and the GBP.
Exotic currency pairs
An exotic currency refers to a currency from a developing economy, sometimes also referred to as an emerging market. An exotic currency pair means an exotic paired with a major. Two exotics can also be paired together, referred to as ‘exotic v exotic.’
Examples of exotic currencies include the Singapore dollar (SGD), the South African Rand (ZAR), and the Mexican dollar (MXN). There are hundreds of other examples, which are too numerous to list here!
Pip is short for Percentage in Point, otherwise expressed as Price Interest Point. A pip refers to the change in value between two currencies.
It is the smallest whole unit price move that an exchange rate can make, and it is usually the fourth (and last) decimal place of a price quote. In some cases, such as with the Japanese Yen pairs, there will only be two decimal places, so the pip will be the second and last decimal place.
For example, the EUR/USD currencies show a move from 1.1440 to 1.1441, then the value of the USD has risen by one pip.
In some cases, forex brokers may quote currency pairs to 5 or 3 decimal places, rather than the standard 4 and 2. This is a fractional pip, or pipette, and it is equal to one tenth of a pip.
Learning how to read pips and pipettes, and calculate their values accurately, is an important skill in forex trading. It’s not that complicated, but it does take some practice, especially because there will be times when you need to read them swiftly and accurately to make a trading decision.
Tracking the changes in pip values (which can be very tiny) as the forex markets fluctuate is the essential work of the forex trader. This then needs to be back up by a sound trading strategy, in order to maximise profits and mitigate and losses.
There is no right or wrong way to go about trading, and even experts make errors of judgement sometimes. However, you must have a solid risk management strategy in place before you open live trading positions.
This refers to the units of base currency in each trade. In forex, a standard lot size equals 100,000 units of the base currency. It is possible to take smaller lot sizes (known as mini lots) of 10,000 units of the base currency, and also micro lots, which are 1,000 units of the base currency.
In some cases, you may even be able to trade nano lots, which are 100 units of the base currency. This makes forex trading accessible to those with smaller amounts of capital to invest. When you place an order on a trading platform, the size will be quoted in lots.
The lot sizes might seem large, but in forex you often need to trade significant amounts of currency in order to turn a profit.
Long and short trades
The term ‘going long’ means that you are buying a currency, as opposed to ‘going short’, when you are selling a currency. Because currencies are always traded in pairs, you will always be going long on one currency and short on the other. You will make your decision to buy or sell a particular currency based on whether you expect its value to rise or fall.
In a forex trade, when buying, or going long, the base currency is purchased and the quote currency is sold. When selling, or going short, the base currency is sold and the quote currency is bought. (The base currency is always the first listed in a currency pair, and the quote currency is second listed.)
Bid price and ask price
The bid price refers to the buying price, and the ask price is the selling price of a currency. The bid price will always be lower, given that the aim is to make a profit. A transaction takes place when a buyer decides to increase their bid price, or a seller decides to lower their ask price, until a sale price is agreed.
The spread refers to the difference between the bid price and the ask price. You may also see it referred to as the bid/ask spread. This is also sometimes referred to as the transaction cost, because the broker takes the spread value as a client fee on the transaction.
Bull markets and Bear markets
The terms bull and bear are used to describe the general trending direction of the financial markets. If a market is described as bullish, it means that investor confidence is high, and the economy is performing well, with high GDP, low unemployment, and low rates of inflation.
A bear market refers to negative economic conditions, where the economy is performing weakly, and unemployment is high. Investors will tend to transfer to safe currencies, such as the USD, as sell off riskier investments.
It is possible to make good profits in both bull and bear markets, if you follow the economic news and latest data releases carefully to help predict which way the market will turn. However, it is not advisable to make reactionary decisions and follow the crowd, because this can often lead to unwise trading choices.
Always let any strong fluctuation in market conditions settle down before making nay major buying or selling moves in the forex market.