13 Key Terms You Need to Know Before You Start Forex Trading

One aspect of learning a skill is talking about it, and you want to be able to have the proper lexicon at your disposal.  Of course, truly learning a skill isn’t about impressing a date, or your friends, but of course, it doesn’t hurt to know the right words to use when discussing forex trading in general.  Even if you are not a forex master by any means, conversations like these can help you network and meet other people who trade, which could help your forex trading career long-term.

 

Major and minor currency pairs in forex

First and foremost, you should be familiar with the major and minor currencies.  The truth is that there are eight currencies that are traded more than any other in the world, and they are called the major currencies.  These are the USD, JPY, EUR, GBP, CHF, CAD, NZD, and the AUD.  They are the most liquid, as well. The minor currencies?  Every other currency!  It’s as simple as that.  That should make it easy to remember!

 

Base currency

 

The base currency, again, is the first currency in a currency pair.  The currency quote will show much this base currency is worth against the second currency.If you see that the USD/CHF rate is 1.72134, what does that mean?  Well, based on what was just explained, you should have answered that this means that one USD is worth 1.72134 CHF.  The USD is the most widely used base pair, and this is also important to remember when it comes to casual conversation, as well.

 

Quote currency

 

The quote currency is the opposite currency in the pair.  So you have the base, and the quote.  One way to easily remember this is that B comes before Q     in the alphabet.  It might sound simple, but sometimes little rules like this can help you manage.

 

Pip

A pip is the unit of price for a currency. Nearly all currency pairs go to a certain amount of digits, and that number is usually five.  Most pairs have the decimal place right after the first number, that’s why you see exchange rates such as 1.5426, and 3.5697.  A pip, therefore, refers to the fourth number after the decimal place.  This is important to remember, because the last thing you want to do is forget exactly what unit a pip is.  It should also be noted that one exception here is the Japanese yen, where a pip equals .01.

 

Pippete (or  point)

 

A pipette is 1/10th of a pip, which should be easy to remember.  Some brokers quote them, and others do not, but knowing the term is essential to avoid confusion.

 

Bid price

The bid price is the price at which the market is prepared to buy a specific currency.  This is the price at which a trader can sell, to meet the market’s demand.  It is always shown on the left side of a quotation. If the quote is GBP, USD 1.8711/1.8714, this means that the bid price is 1.8711.  You can sell one British pound for 1.8711 dollars.

 

Ask price

The ask, or offer price, is the price at which the market wishes to sell a certain currency, and is the price at which a trader can purchase.  Here, the trader can purchase a British pound at 1.8714 dollars, and remember that the “offer” price is simply a synonym for the ask price.

 

Bid- Ask price spread

 

The bid-ask spread is simply the spread, or difference between the bid and the ask.  Here, it is a 3-pip spread.

 

Quote

Quotes are often quoted in terms of pips rather than “big figure quotes”, which explain the entire number.  For example, here, it might be explained that the spread is “11/14”, because this is an easier and faster way of expressing the spread in layman’s terms.Quote convention: Here is how quotes are usually expressed.  First and foremost, remember this:

 

Base Currency/ Quote Currency = Bid/Ask

 

This will certainly help you save a lot of time, and help you not get confused as a newbie.  Understanding quotes is essential to understanding the market, and this is important to remember, not just in lingo terms, but on a basic level.

 

Transaction costs

The transaction cost is simple, it is just the cost of a round-turn trade.  This means that if you were to instantly buy or sell a trade of the same size in the currency pair, how much would it cost?  Would it be three pips, four pips, five?  This is all a transaction cost boils down to:

 

Transaction costs include: 

  • (Spread) = Ask price – Bid Price

  • Comissions (with ECN brokers)

  • Rollovers (when you hold the position overnight)

 

Cross Currency

Cross Currency is a term used for when neither currency is in USD.  For example, a currency pair like EUR/GBP.  Often times, these pairs are a little stranger, since these currency pairs are actually involve USD anyway. When you purchase (go long) on EUR/GBP, you are basically purchasing a EUR/USD pair, and selling GBP/USD.  Cross currencies tend to be a little more erratic and have a wider spread because of this distinction.  

    

Leverage

 

Leverage is simply the ratio of amount capital used in a transaction to the required security deposit, otherwise known as the margin.

Leverage is what allows you to control large amounts of money, without RISKING large amounts of money.

This varies with certain brokers, some of whom only provide 2:1 leverage, and others that are more daring, and offer leverage opportunities such as 500:1.

 

Margin

When you open a new margin account with a forex broker, you have to deposit a minimum amount first and foremost.  

This minimum varies widely and can be as small as $100, and as high as $100,000.  It all depends on the broker and your needs, of course.  This way, every time that you execute a trade, a certain percentage of the account balance, will be set aside as required for the margin.  This way there is actual leverage when the trade is executed, no matter what happens.

 

This amount is based on a couple of factors: the currency pair, the current price, and the number of units.  As you can imagine, it varies based on these factors, because they determine exactly how much should be set aside.  It is easy to see how someone purchasing 10x more units than someone else would require a different amount of money set aside.

If you opened a mini account that provided 100:1 leverage, for example…or 1% margin – here’s how it would work.  First and foremost, mini accounts trade mini lots.  One mini lot, let’s say, is 10,000 units (rather than 100,000 units).

If you wanted to open one mini-lot, you would need only $100!  This is because $10,000 x 1% is $100.



 

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