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. Current world interest rates.

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

For a full list, click here: ISO Currency Codes

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 gearing you can get from your funds expressed in terms of a ratio. e.g. 100:1 leverage implies a 1% margin requirement.

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).