You have probably heard the terms ‘leverage’, ‘margin’ and ‘pips’ in the world of Forex. To begin with, getting a grip on all the language should be the first step. It is essential to have a good knowledge of the terminology before you begin trading Forex.
Everything can affect the market. On Monday it was reported the euro had risen due to Merkel’s victory in the German election. With the uncertainty leading to the future in relation to Merkel’s forming of a coalition, this could all change. The market fluctuates constantly, so understandably it can be confusing to know where to start.
The foreign exchange market (Forex or FX) is continuously growing and one of the most appealing things about the Forex market is that you can trade five days a week, 24 hours a day. It is easier to enter the market as a beginner as opposed to other financial trading markets, and with the rise of popularity there have been stricter guidelines and regulations to protect traders.
Margin allows you to deposit a small amount into your account and trade with considerably more money. It is like a down payment and you are borrowing the rest. Think of margin as a loan from the broker. In simple terms: if you are trading with a broker with a margin of 200:1 this means for every £10 in your account, you can trade £2000. By trading on margin it gives you “leverage”.
In a typical brokerage margin account you have to pay interest on the margin money you borrow. However in a Forex margin account, you don’t owe interest on an initial margin transaction, but if you don’t close your position before the delivery date, it will have to be rolled over, and at that point interest may be due based on based on whether you are long or short and the short-term interest rates of the underlying currencies. If you are borrowing (short) a low interest currency and loaning (long) a high interest currency you can actually earn interest. See Cary Trade.
Useable Margin — amount of money in the account that can be used for trading.
Used Margin — amount of money in the account already used to hold open positions open.
Leverage allows traders to invest more than they actually have, with some brokers offering as high as 400:1 leverage. The advantage of leverage is that even small fluctuations in your direction will give you big gains. The disadvantages of leverage are that similarly, if you are not successful with your prediction, then you could end up losing much more than your original investment.
A ‘pip’ stands for a percentage in point. Most currencies are set to the fourth decimal point. It is 1/100th of a cent.
Bid — The amount someone else is willing to pay you.
Ask — The amount someone else is asking i.e. the amount you will have to pay to get it.
Spread — difference between the bid and the ask prices for a currency pair.
All Forex trades involve two currencies, i.e. simultaneously buying one currency while selling of another. In effect you are borrowing one currency and using the proceeds to buy another but the currency pair itself can be thought of as a single unit, an instrument that is bought or sold.
According to Investopedia: “If you buy a currency pair, you buy the base currency and sell the quote currency. The bid (buy price) represents how much of the quote currency is needed for you to get one unit of the base currency. Conversely, when you sell the currency pair, you sell the base currency and receive the quote currency. The ask (sell price) for the currency pair represents how much you will get in the quote currency for selling one unit of base currency.”
The first currency quoted in a currency pair on Forex is called the “base currency”. It is also typically considered the domestic currency or accounting currency. For accounting purposes, a firm may use the base currency to represent all profits and losses. From its inception in 1999 and as stipulated by the European Central Bank, the euro has first precedence as a base currency. Therefore, all currency pairs involving it should use it as their base, listed first. For example, the US dollar and euro exchange rate is identified as EUR/USD. It is sometimes referred to as the “primary currency”.
If you hold a position overnight (i.e. without closing the position) in hope of gaining profits from the central banks interest rates difference.
The Forex slang name for the Australian dollar or the AUD/USD pair.
The Forex slang term for the New Zealand dollar or the NZD/USD pair.
The Forex traders slang word GBP/USD currency pair. Which originated from the time when a communications cable under the Atlantic Ocean synchronized the GBP/USD quote between the London and New York markets.
Other Slang Pair Names
Fiber for EUR/USD, Chunnel for EUR/GBP, Loonie and The Funds for USD/CAD, Guppy for GBP/JPY, Yuppy for EUR/JPY.
The majors are the primary currencies traded. They are the Euro, US Dollar, Japanese Yen, Pound Sterling, Australian Dollar, Canadian Dollar and the Swiss franc.
Currencies are traded in fixed contract sizes, specifically called lot sizes, or multiples thereof. The standard lot size is 100,000 units of the base currency. Many retail trading firms also offer 10,000-unit (mini lot) trading accounts and a few even 1,000-unit (micro lot).
Make the Most of Trading Tools
Using a margin calculator is a benefit so you can work out what your returns, and similarly, your losses would be.
Research as much as possible and don’t set your sights too high. The marketing surrounding trading is designed to make it look very appealing, but it doesn’t mean that it’s not risky. Use your wisdom and take your time. And practice with a demo account before committing real money.
Image courtesy of Stuart Miles/ FreeDigitalPhotos.net.