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Forex Basics
The following is an introduction to some of the basic terms and
concepts used in forex trading.
Foreign Exchange : The simultaneous buying of one currency and
selling of another.
Foreign Exchange Market : An informal network of trading relationships
between the world's major banks and other market participants,
sometimes referred to as the 'interbank' market. The foreign exchange
market has no central clearinghouse or exchange, and is considered
an over-the-counter (OTC) market.
Spot Market : Market for buying and selling currencies for settlement
within two business days (the value date). USD/CAD = 1 day. Most
dealers will automatically roll over your open positions, allowing
you to hold a position for an indefinite period of time.
Rollover : The process whereby the settlement of a transaction
is rolled forward to the next value date. The cost of this process
is based on the interest rate differential between two currencies.
Exchange Rate : The value of one currency expressed in terms of
another. For example, if the exchange rate for EUR/USD is 1.3200,
1 Euro is worth US$1.3200.
Currency Pair : The two currencies that make up an exchange rate.
When one is bought, the other is sold, and vice versa.
Base Currency : The first currency in the pair.
Counter Currency : The second currency in the pair. Also known
as the terms currency. ISO Currency Codes :
USD = US Dollar
EUR = Euro
JPY = Japanese Yen
GBP = British Pound
CHF = Swiss Franc
CAD = Canadian Dollar
AUD = Australian Dollar
NZD = New Zealand Dollar
Currency Pair Terminology
EUR/USD = "Euro"
USD/JPY = "Dollar Yen"
GBP/USD = "Cable" or "Sterling"
USD/CHF = "Swissy"
USD/CAD = "Dollar Canada" (CAD referred to as the "Loonie")
AUD/USD = "Aussie Dollar"
NZD/USD = "Kiwi"
The following pairs might also be referred to by the following
nicknames:
EUR/USD = "Fiber"
USD/JPY = "Gopher"
EUR/GBP = "Chunnel"
GBP/CHF = "Geppy"
Market Maker :A market maker makes a market for a particular financial
instrument, providing liquidity and a two-way price quote. A market
maker takes the opposite side of your trade.
Broker : A firm that matches buyers and sellers for a fee or a
commission.
Counterparty : One of the participants in a transaction.
Sell Quote : The quote on the left is the price at which you can
sell currency. (Also known as the bid price). e.g. For EUR/USD
1.3200/03, you can sell 1 Euro for US$1.3200.
Buy Quote : The quote on the right is the price at which you can
buy currency. (Also known as the ask or offer price). e.g. For
EUR/USD 1.3200/03, you can buy 1 Euro for US$1.3203.
Spread : The difference between the sell quote and the buy quote.
If the quote for EUR/USD reads 1.3200/03, the spread is 3 pips.
In order to break even, the currency must shift in your direction
by an amount equal to the spread.
Pip : Price Interest Point. The smallest price increment a currency
can make. Also known as points. e.g. 1 pip = 0.0001 for EUR/USD,
or 0.01 for USD/JPY.
Pip Value : The value of a pip. 1 pip = $10 for EUR/USD, GBP/USD,
AUD/USD & NZD/USD with 100k lots, or $1 per pip with 10k lots.
To calculate the pip value of other currency pairs, use a pip
value calculator .
Tick : Minimum change in price
Lot : The standard unit size of a transaction. Typically, one
standard lot is equal to 100,000 units of the base currency, or
10,000 units for a mini.
Standard Account : Trading with standard lot sizes
Mini Account : Trading with mini lot sizes
Margin : The deposit required to open a position. A 1% margin
requirement allows you to open a $100,000 position with a $1,000
deposit.
Leverage : The amount of times the value of your transaction exceeds
your margin. e.g. 100:1 leverage implies a 1% margin.
Long Position : A position whereby the trader profits from an
increase in price. (Buy low, sell high)
Short Position : A position whereby the trader profits from a
decrease in price. (Sell high, buy low)
Market Order : An order at the current market price
Entry Order : An order that is executed when the price touches
a pre-specified level
Limit Entry Order : An order to buy below the market or sell above
the market at a pre-specified level, believing that the price
will reverse direction from that point.
Stop-Entry Order : An order to buy above the market or sell below
the market at a pre-specified level, believing that the price
will continue in the same direction from that point.
Limit Order :An order to take profits at a pre-specified level
Stop-Loss Order : An order to limit losses at a pre-specified
level
OCO Order : One Cancels Other. Two orders whereby if one is executed,
the other is cancelled.
Manual Execution : The order is executed with human intervention.
Automatic Execution : The order is executed automatically by computer
without human intervention or involvement.
Slippage : The difference in pips between the order price and
the price the order is filled at.
Example Transaction : Assume you have a trading account of $20,000
and you have chosen to use 100:1 leverage on your account. The
current quote for EUR/USD is 1.3225/28. You place a market order
to buy 1 lot of 100,000 Euros at 1.3228, expecting the euro to
strengthen against the dollar. At the same time you place a stop-loss
order at 1.3203, and a limit order at 1.3328.
The value of this trade is $132,280 (100,000 * 1.3228) but because
you are using 100:1 leverage, you only need to deposit 1% of the
total, which is $1322.80 ($132,280 * 0.01).
The Euro strengthens against the dollar as expected, rising to
1.3328 where your limit order is reached. Your position is closed.
You have made 100 pips.
Your total profit for this trade is $1,000 (100,000 * (1.3328
- 1.3228)), and the return on your investment is 75.6% ($1000/$1322.80).
Trade Summary :
Opening Balance: $20,000
Leverage: 100:1
Buy: 1 std lot EUR/USD @ 1.3228 = $132,280
Margin Requirement: $1322.80
Position Size: 6.6% of the account ($1322.80/$20,000)
Pip Value: 1 pip = $10
Stop-Loss: 25 pips (representing 1.25% of the account)
Limit: 100 pips
Risk/Reward Ratio: 4:1
Sell: 1 std lot EUR/USD @ 1.3328 = $133,280
Profit: $1,000
Return: 75.6% ($1,000/$1322.80)
Closing Balance: $21,000 (+5% gain)
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