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Impress Your Date with Forex Trading Lingo
from: Scottie Pippin
As in any new skill that you learn, you need to learn the
lingo...especially if you wish to woo your love's heart. You,
the newbie, must know certain terms like the back of your hand
before making your first trade. Some of these terms you've
already learned, but it never hurts to have a little review.
Major and Minor Currencies
The seven most frequently traded currencies (USD, EUR, JPY,
GBP, CHF, CAD, and AUD) are called the major currencies. All
other currencies are referred to as minor currencies. Do not
worry about the minor currencies, they are for professionals
only. Actually, on this site we will only be covering what we
call the Fab Five (USD, EUR, JPY, GBP, and CHF). These pairs are
the most liquid and are the only currencies we actually trade.
Cross Currency
A cross currency is any pair in which neither currency is the
U.S. dollar. These pairs exhibit erratic price behavior since
the trader has, in effect, initiated two USD trades. For
example, initiating a long (buy) EUR/GBP is equivalent to buying
a EUR/USD currency pair and selling a GBP/USD. Cross currency
pairs frequently carry a higher transaction cost. The three most
frequently traded cross rates are EUR/JPY, GBP/EUR, and
GBP/JPY. Base Currency
The base currency is the first currency in any currency pair.
It shows how much the base currency is worth as measured against
the second currency. For example, if the USD/CHF rate equals
1.6350, then one USD is worth CHF 1.6350. In the Forex markets,
the U.S. dollar is normally considered the "base" currency for
quotes, meaning that quotes are expressed as a unit of $1 USD
per the other currency quoted in the pair. The primary
exceptions to this rule are the British pound, the Euro, and the
Australian dollar. Quote Currency
The quote currency is the second currency in any currency
pair. This is frequently called the pip currency and any
unrealized profit or loss is expressed in this currency.
Bid Price
The bid is the price at which the market is prepared to buy a
specific currency pair in the Forex market. At this price, the
trader can sell the base currency. It is shown on the left side
of the quotation.
For example, in the quote EUR/USD 1.2812/15, the bid
price is 1.2812. This means you can sell on U.S. dollar for
1.2812 Euros. Ask Price
The ask is the price at which the market is prepared to sell a
specific currency pair in the Forex market. At this price, you
can buy the base currency. It is shown on the right side of the
quotation.
For example, in the quote EUR/USD 1.2812/15, the ask
price is 1.2815. This means you can buy one U.S. dollar for
1.2815 Euros. The ask price is also called the offer price.
The spread is the difference between the bid and ask price. The
"big figure quote" is the dealer expression referring to the
first few digits of an exchange rate. These digits are often
omitted in dealer quotes. For example, the USD/JPY rate might be
118.30/118.34, but would be quoted verbally without the first
three digits as "30/34". Quote Convention
Exchange rates in the Forex market are expressed using the
following format:
Base currency / Quote currency Bid / Ask
Transaction Cost
The critical characteristic of the bid/ask spread is that it is
also the transaction cost for a round-turn trade. Round-turn
means both a buy (or sell) trade and offsetting sell (or buy)
trade of the same size in the same currency pair. In the case of
the EUR/USD rate of 1.2812/15, the transaction cost is three
pips.
The formula for calculating the transaction cost is:
Transaction cost = Ask Price - Bid Price
Pip
A pip is the smallest unit of price for any currency. Nearly
all currency pairs consist of five significant digits and most
pairs have the decimal point immediately after the first digit,
that is, EUR/USD equals 1.2538. In this instance, a single pip
equals the smallest change in the fourth decimal place, that is,
0.0001. Therefore, if the quote currency in any pair is USD,
then one pip always equal 1/100 of a cent.
One notable exception is the USD/JPY pair where a pip equals
$0.01. Margin
When you open a new margin account with a Forex broker, you
must deposit a minimum amount with that broker. This minimum
varies from broker to broker and can be as low as $100 to as
high as $100,000.
Each time you execute a new trade, a certain percentage of the
account balance in the margin account will be earmarked as the
initial margin requirement for the new trade based upon the
underlying currency pair, its current price, and the number of
units traded (called a lot). The lot size always refer to the
base currency.
For example, let's say you open a mini-account which provides a
200:1 margin or .5% margin. Mini-accounts usually trade
mini-lots which are $10,000. So if you were to open one
mini-lot, instead of having to provide the full $10,000, you
would only need $50 ($10,000 x .5 = $50).
Leverage
Leverage is the ratio of the amount used in a transaction to
the required security deposit (margin). It is the ability to
control large dollar amounts of a security with a relatively
small amount of capital. Leveraging varies dramatically with
different brokers, ranging from 10:1 to 400:1. Margin
+ Leverage = Possible Deadly Combination
Trading currencies on margin lets you increase your buying
power. If you have $5,000 cash in a margin account that allows
100:1 leverage, you could purchase up to $500,000 worth of
currency because you only have to post one percent of the
purchase price as collateral. Another way of saying this is that
you have $500,000 in buying power.
With more buying power, you can increase your total return on
investment with less cash outlay. But be careful, trading on
margin magnifies your profits AND losses. Margin
Call
All traders fear the dreaded margin call. This occurs when your
broker notifies you that your margin deposits have fallen below
the required minimum level because an open position has moved
against you.
Trading on margin can be a profitable investment strategy, but
it is important that you take the time to understand the risks.
You should make sure you fully understand how your margin
account works. Be sure to read the margin agreement between you
and your broker. Talk to your broker if you have any
questions.
The positions in your account could be partially or totally
liquidated should the available margin in your account fall
below a predetermined threshold. You may not receive a margin
call before your positions are liquidated (the ultimate
unexpected birthday gift).
Margin calls can be effectively avoided by monitoring your
account balance on a very regular basis and by utilizing
stop-loss orders (discussed later) on every open position to
limit risk. For ease of use, most online trading platforms
automatically calculate the profit and loss your open positions.
About the author:
Scottie Pippin is a professor from BabyPips.com's School of
Pipsology. BabyPips.com is a free, funny, and easy-to-understand
guide for teaching beginners how to trade in the foreign
exchange market.
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