Basic Forex Terminology

Basic Forex Terminology

Currency trading (also known as Forex trading) has a high learning curve. Beginner traders are advised to start from scratch and digest all the information available.

Understanding basic terms and lingo is an excellent first step.

Bid Price, Ask Price and Spread

Bid is the price the market is willing to pay for a certain currency pair. Ask is the price it is prepared to sell at. So, bid represents demand and ask represents supply for an asset.

Your broker is the one doing ‘bidding’ and ‘asking’. This makes you the ‘price taker’. The bid is the price at which your broker will buy the base currency from you, in exchange for the quote currency. Let’s say for USDCHF pair, the quote is 1.1650/1.655. Then bid is 1.1650 and offer (ask) is 1.1655.

Ask price is also known as the offer. The difference between bid and ask is called the spread. It is your broker’s source of income in exchange for the cost of platform and services that they offer.

Some brokers might offer ‘zero spread’ accounts and charge a commission: a fixed amount for each transaction. But most trading accounts are ‘commission free’ and will show you a spread instead. 

Spread is often measured in pips: the smallest unit of the price movement of a currency pair. For most currency pairs, one pip is equal to 0.0001.

Lots and position sizes

Currencies pairs are traded in fixed amounts called lots. The standard size for a lot is 100,000 units of currency. To make it more easily accessible for retail clients, brokers now offer mini, micro, and nano lot sizes, respectively 10,000, 1,000, and 100 units. 

Opening a position in the currency markets for one lot of EURUSD costs €100,000. But a micro lot would only set you back for €1,000. 

Trading smaller lots is not the same as trading with margin. You can still trade 1 lot of EURUSD but put only €1,000 as collateral (or required margin) if your broker is giving 100:1 leverage. 

The Bulls and Bears

If the price in a market is rising or showing signs of an upwards trend, then the market is called ‘bullish’. This means there are buyers more than sellers and the overall market tendency is to keep buying (or going long). 

Similarly, if the price in a market is falling or showing signs of a downward trend, then we say the market is ‘bearish’. It means that there are more traders in the market who wish to sell or who opened a short position. 

Understanding Currency Pairs

Currency values are relative to each other; that is why we use them in pairs while trading. Let’s use EURUSD as an example. This pair shows you how much one euro (EUR) is worth in US dollars (USD). Instead, if you wanted to see the value of Euro in terms of the Japanese yen (JPY), you would look at the EUR/JPY rate. 

The first currency in a pair is called the base currency. The second is called the counter currency (or quote currency). When you are selling EUR/USD, you are not only selling euros, but you are also buying US dollars. If you think Japanese Yen will gain value over US dollar, you could sell the USDJPY instead. It’s all up to you.

But I don’t have any Euros, how can I sell EURUSD?

In foreign exchange market, you can. When trading a currency pair, you are speculating on the change in rates. You do this by borrowing the euros by default. This allows you access to leverage, which can increase your profits and your losses.

What is a Pip?

Point in Percentage. A pip is the unit in which you calculate your profit or loss.  Most currency pairs, except Japanese yen pairs, are quoted to four decimal places. The smallest price change for a pair counts as one pip. For example, if the EURUSD rises from 1.4022 to 1.4027, that was a 5-pip move. The monetary value of a pip varies according to the size of your trade and the currency you are trading. 

Note: Stock indices have ‘points’, futures have ‘ticks’, currency has ‘pips’.

What is leverage?

The term ‘Leverage’ means being able to trade a larger amount of volume with less investment. To let you control a larger position than your investment, brokers set aside a certain amount as ‘collateral’. For example, one lot of EURUSD costs €100,000. However, if your broker allows 1:100 leverage for trading EURUSD, then you can trade 1 lot of EURUSD with only €1,000. 

Please note that the leverage amplifies the price movement. It means proportionally higher profit or loss for you, depending on the market movement. Therefore, trading CFDs carries a high risk. Please make sure that you understand how CFDs work before starting a live trading account. The best way to manage the risk associated with margin trading is to implement risk management tools in your trading plan.

This post is also available in: Español

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