These days, the popularity of forex trading is higher than ever and many more people are taking an interest in the world’s largest financial market. Before stepping into the forex market, beginners have to indulge in learning and delve into the basic concepts of currency trading. You will come across a lot of jargon that is used by forex traders and understanding the meaning of these forex terms is one of the very first lessons for a newbie trader. You cannot move forward in the trading journey without memorising these terms and their meaning.
It would be hard to cover all of them in one article but I will be sharing the most basic and popular terms that forex traders use on a daily basis. So, let’s get started.
- Pip
The purpose of trading is to make profits from favourable price movements and the price movements in the forex market are measured and expressed in Price Interest Point or Percentage In Point abbreviated as pips. Pips is a key term in forex as the price fluctuations of forex trading instruments are denoted as the number of pips by which the price has moved.
You need to use a pip calculator to find out the exact pip value in the currency you want to trade in. The profits and losses of a trade are dependent on the number of pips you gain or lose in that trade. Having a good understanding of pip is essential for planning and executing trades with perfection.
2. Pipette
Pipette is often confused with pip but it is smaller than pip and denotes a smaller change in price. A pipette is also known as a fractional pip as it represents 1/10th of a pip. Forex brokers often quote the prices in pipettes and you need to understand the difference between the two to avoid mistakes. The value of 1 pip is 0.0001 for all currency pairs except the pairs that have Japanese Yen as for those pairs 1 pip is 0.01. But the pipette is stated in the 5th decimal point and the 3rd decimal point.
3. Currency pairs
In the forex market, exchange rate fluctuations are directly connected to price movements as the trading instruments are currencies and their value is determined by pairing them with another currency. The first currency in a currency pair is the base currency and its value is quoted against the 2nd currency.
The base currency is the one being bought or sold in forex trading and its value against quoted currency is the price of the currency pair. Each currency pair has different characteristics and they are classified as major, minor and exotic pairs.
4. Major currency pairs
Major currency pairs are the pairs with the highest trading volume. These pairs always have USD along with any other major currency like Euro, CAD, AUD, JPY, GBP, CHF and NZD. These are the most actively traded pairs and hence they are the most liquid out of all pairs. Beginners are always advised to start trading with major pairs as they are less risky and easier to trade in comparison. EUR/USD, USD/JPY, AUD/USD etc are some examples of major pairs.
5. Minor currency pairs or Cross pairs
Minor or cross pairs come 2nd in terms of trading volume and liquidity. They are also more volatile than the major pairs. They also have major currencies paired together except the USD. Minor pairs are preferred by many traders due to the volatility which gives more trading opportunities. EUR/GBP, GBP/CAD, NZD/JPY etc can be cited as examples for cross pairs.
6. Exotic currency pairs
Exotic currency pairs are the most volatile and least liquid pairs with a low trading volume. Exotic pairs have the major currencies paired with currencies from emerging or developing economies which makes them riskier to trade with. However, some traders with high-risk tolerance do trade exotic pairs for a higher profit potential. USD/ZAR, EUR/TRY, EUR/PLN etc are the most traded exotic pairs in the market.
7. Lot size or position size
Lot size or position size is the size of your trade position and it is expressed as the number of lots. There are 3 types of lots in forex: standard, mini and micro which are measured with the base currency of your trading account. Standard lot consists of 1,00,000 units of currency and it is the most commonly used lot for trading. Mini lot consists of 10,000 units of currency and micro lot is the smallest with 1000 units of currency.
The amount that you risk for a trade is decided by your position size and hence optimal position sizing is an integral part of risk management. When it comes to risk management, making calculated moves is important. Tools like trading calculators make the task easier and more efficient by providing the required metrics right away.
8. Leverage
Leverage is often compared to a loan from the broker but here you won’t be borrowing money in real but will get to open bigger trades with a smaller amount of trading capital. By availing leverage, you will get to trade with money that you don’t have in your trading account. The size of your trades is amplified with leverage and this maximises your profit potential, which helps in growing your account to a bigger scale.
But the losses you encounter in leveraged trades will be equally bigger and this is why leverage is known as a double-edged sword which can both be beneficial and harmful depending on how you use it. Hence, traders are advised to use leverage in limit and prioritise risk management while trading with leverage.
9. Margin
Margin is the amount of funds that need to be there for placing a trade. Margin is like collateral required by the broker for opening a trade position and keeping it running. When the account balance falls below the required margin amount, the broker will notify you to add more funds which is referred to as a margin call.
Margin calculator is one tool that can save you from this situation as it tells you the required margin before entering a trade based on your account balance, trade size and leverage. Margin calculations are very important for making smart trading decisions and you can get quick and accurate results with a margin calculator.
10. Long and short trades
A long trade refers to a buy position or an order placed for buying in the forex market. A long trade is placed when the trader expects the price of a pair to rise which happens during an uptrend. On the other hand, a short trade is placed when traders expect the value to drop during a downtrend. In such a situation, they enter a sell position by placing an order to sell which is also known as shorting and long trade is stated as going long on a pair.
Traders depend on fundamental or technical analysis for deciding the type of position that needs to be opened to make a profit from the potential price movements. You have to open trade positions after analysing the market situation and finding ideal trade setups that are in line with their strategy.
11. Bid price and ask price
The buying price of a currency is known as the bid price and the selling price is referred to as the ask price. The bid price is what the dealer will be paying when we sell a pair and the ask price is what the dealer will be quoting when we buy the pair. The bid price is always less than the market price while the ask price is slightly higher than the market price.
12. Spread
Spread is the difference between the bid and ask prices of a currency pair. The dealer makes a profit with this spread and you will see the brokers listing the spread of each currency pair on their platform. Spreads are expressed in pips to make the calculation easier and floating spreads tend to be lower than fixed spreads. Another fact that you should know is that the spreads on major pairs are lowest due to the high liquidity while the spreads on exotic pairs are highest due to low liquidity.
13. Bull markets and Bear markets
The buyers in the market are referred to as bulls whereas the sellers are called bears. A market dominated by buyers is a bull market and it is characterised by rising prices. When there are more sellers, the market is bearish and you will see falling prices. A bull market happens when the economies are performing well and weakness in economies leads to a bear market. It is possible to make profits in both types of markets with a solid strategy and risk management plan.
Conclusion
To conclude, learning about various forex terms is essential to understanding the market dynamics and trade without confusion. You can refer to this write-up as a starting point and continue to decode the terminology of forex trading as you move forward.
