Forex trading can be challenging enough especially when first being introduced to new platforms such as the MT4 and MT5. Coupled with an industry that’s filled with unusual terms, acronyms and complex language, it can be a hindrance to a trader’s journey and potential profitability.
Before considering trading on currency pairs, you’ll want to familiarise yourself with some of the common terms used in the world of forex. Understanding these key terms is the first step towards building your knowledge, developing your own trading strategy, and, ultimately, making informed trading decisions.
Currencies are usually traded in specific amounts called lots. A standard lot is 100,000 units, although mini-lots and micro-lots — of 10,000 units and 1,000 units, respectively — are available. Because currencies tend to make small market movements, large lot sizes are needed to see significant profits or losses.
A PIP, or pip, is short for ‘percentage in point’ and is a measure for exchange rate movement. Forex traders make money when currencies change value. A point in percentage, or a “pip,” is the smallest increment a currency can move and is the fundamental unit for measuring currency trades. Usually, this number is $0.0001 when looking at pairs that include US dollars.
For example, if the euro-to-US dollar pair moves from 1.1518 to 1.1520, it’s moved two pips. In order to adequately assess trading risk, you need to try and understand the pip value.
There will usually be a difference between the bid price (how much a broker will pay) and the ask price (the price for which a broker will sell) of an underlying asset. The difference between these prices is called the “spread,” and the wider it is, the more expensive it is for traders.
If a bid-ask quote says EUR/USD = 1.3846/1.3849 the difference is three pips. If you “buy” into this trade, you’ll enter the market at 1.3849 and need the market to move at least three pips to be able to “sell” at a profit.
A spread is essentially the cost of making a trade, hence the importance of understanding what spreads are.
4. Exchange Rate
The goal of forex trading is to buy a currency low and sell when it’s high. The exchange rate lets you know the value of one currency as it relates to another. For example, if the CAD/USD = $0.75, then one Canadian dollar is equal to 75 US cents.
5. Cross Rate
This one’s a little trickier as it has a technical definition and an informal one. Technically, a cross rate is the exchange rate of two currencies, neither of which is the official currency of the country where the quote was given.
For example, if you look at The Wall Street Journal, for the euro-to-Japanese yen quote, that would be a cross rate. However, as Investopedia clarifies, cross rate is often understood as any currency pair that does not include the USD.
The Associated Press, however, defines cross rate still differently: “The rate of exchange between two currencies calculated by referring to the rates between each and a third currency.”
6. Major pairs
Currency pairs can be grouped into major pairs, cross pairs, and exotic pairs. Major pairs are pairs that include the US dollar as either the base currency or counter-currency as well as one of the other seven major currencies (EUR, CAD, GBP, CHF, JPY, AUD, NZD.)
If you’re new to currency trading, it’s best to focus on the major pairs since they often offer low transaction costs and enough liquidity to avoid high slippage. Examples of these major pairs include EUR/USD, GBP/USD and USD/CHF.
7. Cross pairs and exotics
Cross pairs include any two major currencies except the US dollar. Unlike major pairs, cross pairs have higher transaction costs and, at times of lower liquidity, traders can face slippage.
Cross pairs are usually more volatile than major pairs. Examples of cross pairs include EUR/GBP, EUR/CHF and AUD/NZD.
Exotic pairs include those currencies which are not in the major most traded currencies, such as the Mexican peso, Turkish lira or Cze
To trade currencies, you must deposit money into an account. This is your balance. Margin is the amount of your balance needed to open a new position (trade), essentially it’s considered as the minimum deposit. This margin allows you to effectively take a ‘loan’ – access to a larger amount of capital.
It’s important to understand that you don’t need to put up the full amount of a trade you wish to make — only a certain portion defined by your broker. That portion is the “margin requirement,” and it’s made possible by acquiring leverage.
So, how do you calculate the margin per trade?
An account leverage ratio is used to determine how much margin will be required.
Overall Lot Size / Leverage Amount = Margin Required
A margin call is a notification you will receive when there are not enough funds in your trading account supporting open trades – when your floating losses are greater than the minimum margin required.
So what’s this magical leverage we’re talking about? In general, leverage is the ability to use other people’s money to enter a transaction, it can heighten both profits and losses and should be used wisely.
Leverage is offered by brokers as a loan sometimes as high as 200 to 1. Let’s say you want to trade $100,000 of currency. The broker requires a margin of 1 percent and will offer leverage of 100 to 1. This means that you can make the trade using only $1,000 of your $10,000 balance, secure the $100,000 trade and still have $9,000 available in your trading account for additional positions.
Starting out in the forex world can be a little like getting on a bike for the first time mixed with learning a new language. By putting in a little time up front to learn the lingo and understand the bigger picture of how this market works, you can get comfortable and start trading with confidence. Register your account now.
Risk disclaimer: CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money. Never deposit more than you are prepared to lose. Professional client’s losses can exceed their deposit. Please see our risk warning policy and seek independent professional advice if you do not fully understand. This information is not directed or intended for distribution to or use by residents of certain countries/jurisdictions including, but not limited to, USA & OFAC. The Company holds the right to alter the aforementioned list of countries at its own discretion.