Table of Contents
Chapter 1: What is Forex Trading
Chapter 2: History of Money and Origins of Forex Trading
Chapter 3: Forex Trading Terminology
Chapter 4: Important Aspects of Forex Trading
Chapter 5: Players in The Forex Market
Chapter 6: Factors that Affect the Forex Market
Chapter 7: Risks Involved With Trading Forex
Chapter 8: Why Trade in the Forex Market
Chapter 9: How Forex Trading Works
Chapter 10: How to be a Successful Forex Trader
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Chapter 3: Forex Trading Terminology
– Pips
– Spread
– Intraday
– Direct, Indirect and Cross Currency Pairs
– Lots
– Leverage
– Margin Call
– Stop Loss
Chapter 3: Forex Trading Terminology
Having a good understanding of the various terms and calculations used in a trade in the forex market will help you better analyze market information. Here are some of the commonly used terms in the forex market:
- Pips
- In order to make sense of price movement in a currency pair, a trader need to understand the concept of pips. The price movement of a currency pair is measured in pips. Consider this example:
Quote on July 1: USD/JPY= 118.20
Quote on July 2: USD/JPY= 118.25The currency pair has moved 5 pips, which is the difference in ‘points’ in the last decimal place in the quote. The Japanese Yen has moved down in value and a trader would now need 118.25 yens to buy one US dollar. One pip is equal to a movement of 1% in a currency pair where Yen is the counter currency.
In a EUR/ USD pair, a pip would be the change in the fourth decimal place in the currency pair. One pip in this transaction would be equal to a price movement of 0.01%.
The movement in pips is what makes the forex trade possible. A trader who has a position on a currency pair in this example will track the pips to determine by how much the value of Yen is dropping. Every pip movement in a currency pair can be translated into the equivalent change in terms of dollars, which in turn determines the profit or loss of a trader.
- Spread
- A trader gleans market information from the pip movement but he also needs to know at what price he can actually sell or buy his currency pair in the market. The bid / ask price gives him this information. Consider this example:
USD/ JPY = 118.20/ 25
The trader can sell at 118.20 but he can buy only at 118.25. This difference between the bid and ask price is called the spread. Dealers make their profits from spreads in currency trades.
- Intraday
- The prices of various currencies traded in the forex market change constantly through the day. A trader can track the intraday fluctuations with great care to come out on top with his currency pair at the end of the day. Intraday refers to the movements and changes in the price in a day.
- Direct, Indirect and Cross Currency Pairs
- A direct currency pair in the US is one that uses the dollar as the base currency, while the foreign currency is used as the quote currency. On the other hand, a pair that uses a foreign currency as the base is referred to as an indirect pair. A cross currency pair in the US is one where dollar is not one of the currencies being traded.
- Lots
- The price change in each unit of currency is very small to make gains for the trader. It is the sheer size of the average transaction that makes forex so lucrative for investors. Currency pairs are typically traded in lots of 100,000 units of the base currency. This is called one ‘lot’.
- Leverage
- Leverage is an important aspect of forex trading and is responsible for the huge gains that can be made here. The term refers to how much an investor can borrow to facilitate his transaction. In forex trading, an investor can borrow a major portion of his total investment. In other words, he can make a huge investment with a very small proportion of the total amount as capital.
The investor’s minimum required margin, which is set by his dealer, determines his leverage. When he opens a margin account with his dealer, the dealer specifies the leverage he will be allowed. Typically, a 50:1 or 100:1 leverage is allowed. A 50:1 leverage means that you can borrow $50 dollars for every $1 of your own capital. A $100,000 trade will thus require just a $2,000 investment from your side.
- Margin Call
- A broker makes a ‘margin call’ to the borrower asking him to replenish funds in his margin account to cover minimum margin requirements. A trade that goes the opposite way to the investor’s expectations can deplete his account and bring the balance below accepted minimum levels. Once the broker issues a margin call in such a scenario, the trader must immediately deposit funds into his account.
- Stop Loss
- A stop loss is a trigger that helps a trader curb his losses. A smart investor will study his investment to understand the level at which he must pull out in order to keep his loss to a minimum. This level is called the stop loss level.
The investor sets a stop order to give the dealer standing instructions to execute either a buy or sell at stop loss level to break an unfavorable trend in the trade. When the transaction reaches the stop loss level, the action of buying or selling is triggered off.
Next Chapter: Important Aspects of Forex Trading
