Forex trading can be a daunting task for beginners. There are a lot of things to keep in mind while trading. One such thing is the terms used in Forex. There is a plethora of terms to keep up with, and you need to understand what they mean in order to trade successfully. In this article, we discuss the forex terms every trader should know.
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Top 10 Forex Terms
The Forex industry is full of unusual terms, acronyms, and words. The basic terminologies of trading can be a tad intimidating for beginners. But worry not, we have got you covered. A basic understanding of forex terms will help you get comfortable with trading. Read on to learn some of the core terms which every Forex trader should know.
Margin
Margin is the initial capital that a trader needs to open a position and hold it. It is expressed as a percentage of the total position size. This money acts as collateral for the brokerage to cover any losses if the trade goes against the trader.
When trading with margin, the trader only needs to put forward a percentage of the full value of a position in order to open the trade. Margin is calculated as (Amount of Shares * Price of Share) / (Market Value of Position).
Some of the key terms related to margin are:
- Used margin – It is the amount in your trading account that is used to open and maintain a position.
- Free margin – It is the amount in your trading account that is available to open new positions.
Currency Pair
It is the quotation of one currency unit against another currency unit. When you buy one currency, you sell the other. There are many different currency pairs to trade. For example, the euro and the US dollar together make up the currency pair EUR/USD. The first currency that appears is called the base currency, and the second one is called the quote currency.
Currency pairs are divided into three main categories: major, cross, and exotic pairs.
Major Pairs are the pairs of currency that are most commonly traded. They include:
- EUR/USD
- USD/JPY
- GBP/USD
- AUD/USD
Cross Pairs are currency pairs that do not include the US dollar. The most common ones are:
- EUR/GBP
- NZD/JPY
- CHF/JPY
Exotic Pairs are currency pairs that involve less commonly traded currencies, such as:
- EUR/TRY
- USD/MXN
- CAD/JPY
Currency pairs are well-known for representing the relative value of one currency in regard to another. If the CAD/GBP exchange rate is 0.57 then this means that 1 Canadian Dollar is ‘worth’ 0.57 British Pounds. On the flipside, if the GBP/CAD is 1.76 then this means that 1 British Pound can buy you 1.76 Canadian Dollars.
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Leverage
This term refers to the use of borrowed money to increase one’s buying power in the forex market. You can use leverage to trade larger amounts of currency than what you have in your trading account. This is executed by making use of the lender’s capital. This helps make trading look more attractive by only investing a small percentage of the total asset’s value.
The advantage of leverage is that if the position grows, this is enough to make a profit, but if the position decreases in value, it can lead to huge losses. If you’re still a forex beginner who’s not completely familiar with all the forex trading terms, it wouldn’t be the best idea to start using leverage.
Once you start using, consider trading on a lower leverage until you gain enough experience and screen time. This will reduce losses and make sure that you stay in the game in the long run.
Bid/Ask Price
At any given moment, each currency pair has two exchange rates or prices – the bid price and the ask price. They refer to the prices of currencies when buying and selling, as well as the difference between those two prices.
The bid price is the highest amount of money at which buyers are willing to buy, while the ask price is the he lowest amount of money at which sellers are willing to sell. The bid price is always lower than the ask price. Once those two prices meet, a transaction occurs.
Exchange Rate
It is the rate at which you exchange one currency for another. It shows the price of the base currency expressed in terms of the counter-currency. For example, if the exchange rate of EUR/USD is 1.15, this means that one euro costs $1.15, or it takes $1.15 to buy one euro.
Exchange rates are determined by a variety of factors, such as supply and demand, economic conditions, and political stability, and can be either floating or fixed.
- Floating exchange rate: The value of the currency is determined by the market and can change from moment to moment.
- Fixed exchange rate: The value of the currency is set by a central bank and remains constant. Danish Krone is a popular example for fixed exchange rate. It is fixed to the euro at 7.4 DKK per 1 EUR.
PIP
PIP is the acronym for Point In Percentage. The pip is the smallest unit of the currency in a foreign exchange. It is the size of the smallest change in price that your broker accepts. It generally refers to 1/100th of 1% or 0.0001.
For example, if EUR/USD is currently trading at 1.1558 and rises to 1.1562, that rise would equal to a change of 4 pips.
Lot
A lot is the size of trade/ position that you will open. One standard lot has 100,000 units of the base currency, while a micro lot has 1,000 units. For example, if you buy 1 standard lot of EUR/USD at 1.3125, you buy 100,000 Euros and you sell 131,250 US dollars.
Spread
It is the difference between the ask price and the bid price. The spread represents the brokerage service costs and replaces transaction fees.
There are fixed spreads and variable spreads:
Fixed spreads maintain the same number of pips between the ask and bid price, and are not affected by market changes.
Variable spreads increase or decrease according to the liquidity of the market. Forex will always exhibit variable spreads.
Spread can also vary depending on the account you have. Spread-only accounts will have larger spreads compared with more professional accounts.
Equity
Equity is the value of the trader’s position after any pending trades are settled. It is usually denoted by the symbol “EQ.” It refers to the percentage of ownership that a shareholder has in a company.
A positive equity means that one has made profit trading, and a negative equity means that one has encountered a loss.
Bear Market/ Bull Market
A bear market is a market trend in which prices are falling and investors are selling off their holdings. A bull market is a market condition in which prices are rising and investors are buying up assets, leading to price increases. These provide possibilities for traders to make profits, depending on their trading strategy.
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