Forex Terminologies (Dictionary)
In this tutorial, you will learn basic Forex terminologies and its components that you will be dealing with every day. You can treat this almost like a Forex dictionary.
Let’s dig right into these popular terms as an introduction point.
- Bid – Refers to buying price of an instrument
- Ask – Refers to the selling price of an instrument
- Liquidity – Refers to the market volume, higher liquidity means more trading volume and less liquidity means low trading volume.
- Trading volume – Amount of money traded
- OTC – Over the counter
- Exchange rate – The difference in the value of the currency; for instance, a euro is valued at 1.1860 of a US dollar
- Central bank – The biggest financial institution of a country that exercises authority over the value of the currency
- Hedge funds – Big mutual funds corporations that trade large sums of money and can influence the value of the currency through speculation.
Now let’s move on to the more comprehensive terms of the Forex Trading.
When you trade Forex, you don’t just trade one currency, in fact, you trade two currencies against each other. The two currencies that are traded together are known as a currency pair. In a Forex currency pair, the quote for the currency pair defines the value of one currency relative to the other. The first currency in the pair is titled as the base currency, while the second currency is called the counter currency.
The simplest way to understand a quote is to read the pair from left to right. Let’s take an example of EUR/USD pair which is also the most traded pair in the Forex market. In this pair, the Euro (EUR) is the base currency, while the US dollar (USD) is the counter currency. To elaborate it further, let’s say the quote for EUR/USD is 1.1800, in this quote 1 euro is equal to 1.1800 US dollars or in other words you need 1.1800 US dollars to buy one euro. Let’s take one more example using the USD/CAD pair. If the USD/CAD is quoted at 1.3150, that means 1 US dollar is equal to 1.3150 Canadian dollars.
Remember, even though a currency pair consists of two currencies but the pair itself acts as a single entity. It simply acts like a commodity or stock, just like when you buy a stock, you will profit when the price of the stock will increase and you will lose when the price of the stock will decline. In Forex trading, you can also profit from a declining currency pair by short-selling it. You will learn about short selling later in this tutorial. For now, let’s find out more about the major currency pairs.
Major Currency Pairs
The seven most traded currency pairs in the Forex market are called the major currency pairs. These seven major currency pairs include the US dollar either as a counter or quote currency. The major pairs provide high liquidity and low trading spreads which results in low costs trading.
These major currency pairs are: EUR/USD, GBP/USD, AUD/USD, NZD/USD, USD/CHF, USD/JPY, and USD/CAD.
Cross Currency Pairs
The cross currency pairs are those pairs that do not include the US dollar either as a quote or counter currency. Some of these pairs are EUR/JPY, GBP/NZD, EUR/CHF, and so forth. The cross-currency pairs usually provide low market liquidity and spread than the major currency pairs. That is why the trading cost of cross currency pairs is usually high but at the same time, these currency pairs also allow to profit from substantial trading opportunities.
Exotic Currency Pairs
An Exotic currency pair refers to a pair that includes a major currency and the currency of a developing economy such as EUR/TRY (Euro vs Turkish Lira), USD/ZAR (US dollar vs South African Rand), and AUD/MXN (Australian Dollar Vs Mexican Peso). The exotic pairs usually provide lower liquidity and can be extremely unpredictable. The trading cost of exotic currency pairs is generally very high and they should not be traded with adequate fundamental and technical knowledge.
A lot refers to the specific quantity in which the currency pairs are traded. Basically, the lot defines the size of your trade. Modern Forex brokers provide flexible lot size options which are micro, mini and standard lots. For example, a 1000 euro trade is a micro lot, a 10,000 euro trade is a mini lot and a 100,000 euro trade is a standard lot.
To understand it further let’s assume that you wanted to buy a mini lot of EUR/USD, it would mean you will be trading an amount of 10,000 euros. Likewise, if you wanted to buy a standard lot you will be trading an amount of 100,000 euros. You can any amount of lots depending on the available balance in your trading account.
Remember that the actual deposit that you need to buy or sell a lot depends on the leverage that your broker offers. We will also learn about leverage in this tutorial.
Pip stands for Point in Percentage and it is the unit to express the change in the exchange rate.
For example, a price change in EUR/USD from 1.1710 to 1.1711 is 0.0001 in dollar terms and is called one pip movement. The major currency pairs in Forex are quoted to four decimal places except for the USD/JPY which is quoted to two decimal places. So in USD/JPY, a move from 105.20 to 106.21 is 0.01 which is a one pip movement in dollar terms.
To calculate the pip value of EUR/USD or a pair that is quoted to 4 decimal places you need to divide 0.0001 by the current market price and multiply the result with your lot size.
So in the above example of EUR/USD if you divide the 0.0001 by 1.1711 it equals 0.0000853898. Now in the send step, you need to multiply the result with your lot size. Let’s say you traded a standard lot (100,000) so the one pip value for the EUR/USD pair will be $8.538.
Similarly, to calculate the pip value of USD/JPY you will divide 0.01 by current market price and then and multiply the result with your lot size. So for example, if you traded a standard lot (100,000) at 105.20, you will divide 0.01 by 105.20 which equals 0.000095057 and then multiply the result with 100,000 which will give you a pip value of $9.505.
Spread refers to the gap between the ask and bid prices of a currency pair. For example, if the NZD/USD is trading at an ask price of 0.6510 and a bid price of 0.6508 then the spread will be the ask minus the bid price which equals to 0.0002 or two pip. For yen based currencies like USD/JPY the spread is again the difference between the ask and the bid price so if the USD/JPY is trading at an asking price of 105.15 and a bid price of 105.13 then the spread will be 0.02 which equals to two pips.
As a Forex trader, you should always remember that the higher the spread is the higher your trading cost will be. Like in the above example of NZD/USD, if you buy the pair at 0.6508 you will first have to wait for the price to increase by two pips just to breakeven on that trade.
Spread is the leading income source of the Forex brokers, many brokers now offer two different types of accounts that are fixed spread and variable spread accounts. In a fixed spread account, the spread remains the same regardless of market volatility. Whereas in the variable spread accounts the spread continuously changes based on market volatility.
Both types of spreads have their advantages and disadvantages. Fixed spread accounts usually result in requotes from the brokers. In variable spread accounts, the requotes are not frequent but the widening spread raises the trading cost. In a nutshell, you should prefer to trade with a broker that offers low spread so that you can keep your trading cost lower.
The Forex market is exceptional when it comes to trading opportunities. It offers the investors to profit from both the rising and the falling markets. As a trader, when the market price is rising, you aim to buy at a low price so that you can sell at a higher price and make a profit. But the market does not always rise and falls down as well.
So in Forex trading, the process of selling a currency pair first and buying it later is called short selling. In this form of trading, you first aim to sell a currency pair at a higher price and then buy it later at a low price. The difference between selling and buying turns out to be your profit or loss.
It is no doubt that at the beginning, short-selling may sound a weird concept to you. So, to get familiar with it you can relate it to a practice of borrowing with an agreement to return the product to the lender at a later stage. Once you borrow the product you instantly sell that at the market price, and then you wait for the price to fall so that you can buy the product at a lower price and return it to the lender. In Forex trading, the FX brokers facilitate you to short sell by acting as a lender.
Leverage in Forex trading empowers you to make big trades with a fairly small amount of money. To understand how leverage works, let’s say that your analysis recommends that the euro will rise against the US dollar. You are so poised that you would even trade a 100,000 Euros (standard lot) but you don’t have this huge amount in your trading account. So, to trade more than the amount in your trading account you will use the leverage facility provided by your broker. You can borrow a hundred, two hundred, or even four hundred times of your deposit and place the trade. So, in simple words, using leverage you can execute trades more than the accessible capital in your trading account.
Controlling the leverage is in your hand, for example, if your deposit is just one 1000 euros and your trade is also 1000 then you are not using the leverage or you can say your leverage ratio is 1:1. In case if you plan to trade more, for instance, 100,000 Euros with just 1000 Euros then you are exercising leverage of 100:1. Forex Brokers offer different leverage ratios that vary between 1:20 to 1:500.
Always remember that the leverage is a dual-edge sword. It raises your profit percentage but at the same time, it also raises your risk exposure. When you use to leverage the available amount in your trading account serves as collateral and as soon as your floating loss equals the available balance in your trading account the brokers will liquidate your positions. So if you are using high leverage the chances of losing your entire capital are also high. As a new trader, you should always start trading with low leverage and avoid unnecessary risks until you have learned and gained enough experience.
Forex Trading Hours
The Forex market runs 24 hours a day five days a week and goes by the trading sessions. Having information about the timing of these
Forex trading sessions will help you to decide your trading hours. The major Forex trading sessions include the London Session, New York Session, Sydney session, and the Tokyo session. The trading volume differs from session to session, the most active trading session in terms of trading volume is the London session that is followed by the New York session. The trading activity reaches its highest when the London and New York sessions overlap.
If you happen to trade from the United States, the following time frames would apply to you: New York will open when it is 8:00 a.m. Europe will open when it is 2:00 p.m. London when it is 3:00 p.m.