Basic Forex TradeTerminology, Concepts and Definitions
Forex Trading Terminology
Trading the stock and Forex markets, by themselves, can be challenging. We will try to make the process easier by helping you to understand the basic concepts and terms that Forex traders, dealers, brokers, commentators, and fund managers use. While this article is focused on Forex trading, most of the concepts and terms also apply to trading in other financial markets.
Appreciation - An increase in the value of a currency or trading instrument.
Base currency - The base or home currency; it is the first currency that appears in a currency pair (i.e. EUR in EURUSD).
Bear - Someone who believes prices are heading down, and will continue to fall.
Bear Market - A bear market is defined as one in which there has been a sustained fall in prices, and there is no sign the market will change direction in the near future.
Bid/Ask Prices - There are always two prices quoted to a trader, a bid price, and a ask price. If the trader buys a currency pair, he will be entered using the ‘ask price’ or the ‘bid price’ when a currency pair is sold.
Bull - A bull is defined as someone who is optimistic about the market, or who expects prices to go up.
Bull Market - In a bull market, prices are consistently on the rise, on the back of trader enthusiasm and continuous buying. As a result, prices show no sign of turning around in the short-term.
Carry Trade - The carry trade is a common Forex trading strategy by which traders seek to profit from the difference in interests rates of two currencies. To do this, the trader buys the currency with the higher interest rate and sells the one with the lower rate. For example, if the interest for the Euro is 4%, and the Japanese Yen is 1%, buying the EUR/JPY will earn the trader 3%. This Forex trading strategy seems to only work when the financial markets, in general, are bullish.
Cross Currency - A cross currency pair is one that does not include the USD (i.e. EUR/JPY and the EUR/GBP).
Cross rate - An exchange rate that is calculated from two other exchange rates. For example you can calculate the AUD/JPY rate by dividing the USD/JPY by the AUD/USD (AUD/JPY= USD/JPY/AUD/USD).
Currency Nicknames – Besides their official names, currencies are often referred to by their nicknames. Some popular ones include: the green back which refers to the US dollar, and the Loonie which refers to the Canadian dollar. Below is a list of the most popular currencies, along with their symbols and nicknames.
AUD – Country: Australia, Currency: Dollar, Nickname: Aussie
CHF – Country: Switzerland, Currency: Franc, Nickname: Swissy
CAD – Country: Canada, Currency: Dollar, Nickname: Loonie
EUR – Country: Euro members, Currency: Euro, Nickname: Fiber
GBP – Country: Great Britain, Currency: Pound, Nickname: Cable
JPY – Country: Japan, Currency: Yen, Nickname: Yen
NZD – Country: New Zealand, Currency: Dollar, Nickname: Kiwi
USD – Country: United States, Currency: Dollar, Nickname: Buck
Currency Pair - A currency pair is a trading instrument comprising two separate currencies, such as the Euro and the US dollar, which make up the EUR/USD pair. The first currency is usually referred to as the base or transaction currency and the second as the quote, payment or settlement currency. The currency pair is a way of stating the cost of converting one unit of the base currency to the counter currency. Using the EUR/USD as an example, if the current rate is 1.5000, it would cost US$1.50 to buy one Euro.
Depreciation/Decline - A fall in the value of a currency.
Exchange Rate - The exchange rate is what one currency is worth in terms of another, or when exchanged for another. Countries can determine their exchange rates in a variety of ways.
- A floating exchange rate system allows the market to determine the correct price of the currency. This is allowed to happen with minimal intervention from the government and/or the central bank.
- In a fixed exchange-rate system, the government and/or the central bank set the exchange rate.
- A crawling or flexible peg system is a combination of a fixed rate and frequent small adjustments. This system may be used to control speculation about the revaluation or devaluation of the base currency.
Forex, FX, Foreign Exchange - The names that are used to refer to the markets in which currencies are traded.
Fundamental Analysis - Currency traders who speculate on the direction of a currency pair based on their interpretation of economic data, geopolitical events, and natural phenomena are using fundamental analysis.
Interbank – This refers to borrowing and lending between banks, as distinct from transactions with other institutions, clients and retail customers.
Interest Rate differential - The yield spread between two comparable debt instruments, denominated in different currencies. Higher spreads generally make currencies more attractive. As a result, traders tend to be bullish on these instruments (i.e. the carry trade).
Leverage - Leverage is a loan facility that is offered by your broker to allow traders to trade multiples of what their account balance could normally trade. In essence, the investor only funds a part of the traded. For example, using a leverage of 100:1, on an account with a $2,000 balance, could finance a trade worth $200,000. Leveraging allows Forex traders to multiply their profits but it also works in reverse, to magnify trade losses as well. The leveraging concept is not confined to the Forex market, but is quite common in other financial markets as well, such as equity trading.
Long - A trade position that will earn money if the market goes up.
Long position - A long position is a bullish trade, or one that expects the market to go up.
Lot size - A lot size is the standard unit size of a transaction. A standard lot is equal to 100,000 units of the base currency; a mini lot is 10,000 units, and a micro lot is 1,000 units. However, some forex brokers will allow trade sizes as low as 1 unit.
Liquidity - The capacity to be easily converted, with minimal loss. A liquid market is one in which there is enough activity to satisfy both buyers and sellers. The currency market is the most liquid of all the financial markets, with over $3.2 trillion traded on a daily basis.
Limit Order - This is an order to buy or sell, at a pre-determined price that the market is expected to reach some time in the future. Instead of entering a trade immediately (market order), a limit order may be used to enter a trade once a certain price move has occurred, such as a breakout. This entry strategy is used if it is believed that prices will reverse direction at a pre-determined level, such as at an EMA line or pivot point.
Margin - The deposit or account balance that is required when entering a trade position, as well as to hold an open position on a leveraged trading account. Usually, your margin status can be monitored from the account summary of your trading platform.
Margin Call – Margin calls occur when a Forex broker closes all open trades on a leveraged trade account. They do this when the net asset value of an account falls below a certain percentage of the trading capital, or if you have no margin to hold the trade in a situation where the market is moving against you.
Market Order – This is an order to buy or sell at the current market price.
OCO Order - An OCO (One Cancels Other) is an order that cancels another pending order, when certain conditions are met. For example, if limit orders are open for the EUR/USD and the AUD/USD, you may use an OCO order to cancel the EUR/USD limit order, if the AUD/USD order is execute. You may do this to prevent your account from being overexposed by having two USD trades open at the same time.
Open position - A trade that has not yet been closed or exited.
Over the counter - When trading takes place directly between two parties, rather than on an exchange. This term also applies to forex transactions that occur in banking institutions.
Pips - A pip is the smallest unit by which an exchange rate changes. For example, if the AUD/USD moves from 1.8800 to 1.8900, the currency pair is said to have moved 100pips.
Position - This simply means to have a long or short trade on an instrument. “Position” can also refer to a trader’s cash balance.
Secondary/Counter/Settlement Currency - The currency that’s traded against the base currency (i.e. USD in EUR/USD).
Short position - A short position is a bearish trade position, or one that expects the market or trade instrument to go down. A short position benefits from declining market prices.
Short - A trade position that will earn money if the market goes down.
Speculative - Buying and selling in the hope of making a profit, rather than doing so to meet an actual need.
Spot - The current market price of an instrument.
Spread - The difference between the bid and the ask rate. It can also be referred to as the cost of entering a trade on a particular instrument.
Stop-Loss Order - A stop loss is an order that restricts losses by exiting a bad trade, or prevents the market from taking back money on a positive trade. A stop loss is executed once the market reaches the pre-determined price.
Technical Analysis - No Forex trading glossary would be complete without a definition of technical analysis. Technical analysis is the process of analyzing price charts and technical indicators to determine the likely price direction and range of an instrument, or currency pair in the case of forex trading. The process involves the use of technical indicators such as EMA lines, Pivot Points, RSI and MACD indicators to forecast price targets, identify good trading opportunities and discover support and resistance levels, etc.
Trailing Stop-Loss - This is also a stop loss, but the objective of using a trailing stop is to lock in profits on a trade that is already positive.
