Understand Forex Terminology

You need to learn the terminology in any new skill especially if you wish to take it serious and further in life. You, as a forex trader, must know certain terms like the back of your hand before making your first trade. Some of these terms you’ve already learned, but let’s take a recap to refreshen your memory.

Major and Minor Currencies

The eight most frequently traded currencies (USD, EUR, JPY, GBP, CHF, CAD, NZD and AUD) are called the major currencies. All other currencies are referred to as minor currencies.

Base Currency

The base currency is the first currency in any currency pair. It shows how much the base currency is worth as measured against the second currency. For example, if the USD/CHF rate equals 1.61350, then one USD is worth CHF 1.61350. In the Forex markets, the U.S. dollar is normally considered the “base” currency for quotes, meaning that quotes are expressed as a unit of $1 USD per the other currency quoted in the pair. The primary exceptions to this rule are the British pound, the Euro, and the Australian and New Zealand dollar.

Quote Currency

The quote currency is the second currency in any currency pair. This is frequently called the pip currency and any unrealized profit or loss is expressed in this currency.

Pip

A pip is the smallest unit of price for any currency. Nearly all currency pairs consist of six significant digits and most pairs have the decimal point immediately after the first digit, that is, EUR/USD equals 1.25308. In this instance, a single pip equals the smallest change in the fourth decimal place ‐ that is, 0.0001. Therefore, if the quote currency in any pair is USD, then one pip always equal 1/100 of a cent.

One notable exception is the USD/JPY pair where a pip equals $0.01.

NOTE: The last digit is called a point (0.00001)

Bid Price

The bid is the price at which the market is prepared to buy a specific currency pair in the Forex market. At this price, the trader can sell the base currency. It is shown on the left side of the quotation.

For example, in the quote GBP/USD 1.88212/15, the bid price is 1.88212. This means you sell one British pound for 1.88212 U.S. dollars.

Ask Price

The ask is the price at which the market is prepared to sell a specific currency pair in the Forex market. At this price, you can buy the base currency. It is shown on the right side of the quotation.

For example, in the quote EUR/USD 1.12812/15, the ask price is 1.12815. This means you can buy one Euro for 1.12815 U.S. dollars. The ask price is also called the offer price.

Bid/Ask Spread

The spread is the difference between the bid and ask price, this is how much broker make their profits. There are two types fixed and floating spread. Fixed spread is fixed throughout the day while the floating spread just as the name suggest it float (vary) throughout the day.

Quote Convention

Exchange rates in the Forex market are expressed using the following format:

Base currency / Quote currency   —-                Bid / Ask

Cross Currency

A cross currency is any pair in which neither currency is the U.S. dollar. These pairs exhibit erratic price behavior since the trader has, in effect, initiated two USD trades. For example, initiating a long (buy) EUR/GBP is equivalent to buying a EUR/USD currency pair and selling a GBP/USD. Cross currency pairs frequently carry a higher transaction cost.

Margin

When you open a new margin account with a Forex broker, you must deposit a minimum amount with that broker. This minimum varies from broker to broker and can be as low as $100 to as high as $1,000.

Each time you execute a new trade, a certain percentage of the account balance in the margin account will be set aside as the initial margin requirement for the new trade based upon the underlying currency pair, its current price, and the number of units (or lots) traded. The lot size always refers to the base currency.

For example, let’s say you open a mini account which provides a 200:1 leverage or 0.5% margin. Mini accounts trade mini lots. Let’s say one mini lot equals $10,000. If you were to open one mini‐lot, instead of having to provide the full $10,000, you would only need $50 ($10,000 x 0.5% = $50).

Leverage

Leverage is the ratio of the amount capital used in a transaction to the required security deposit (margin). It is the ability to control large dollar amounts of a security with a relatively small amount of capital. Leveraging varies dramatically with different brokers, ranging from 2:1 to 1000:1.

Margin Call

All traders fear the dreaded margin call. This occurs when your broker notifies you that your margin deposits have fallen below the required minimum level because an open position has moved against you.

While trading on margin can be a profitable investment strategy, it is important that you take the time to understand the risks. Make sure you fully understand how your margin

Account works, and be sure to read the margin agreement between you and your broker.

Always ask any questions if there is anything unclear to you in the agreement.

Your positions could be partially or totally liquidated should the available margin in your account fall below a predetermined threshold. You may not receive a margin call before your positions are liquidated (the ultimate unexpected birthday gift).

Margin calls can be effectively avoided by monitoring your account balance on a very regular basis and by utilizing stop‐loss orders on every open position to limit risk.