A Crash Course in Basic Forex Terminology
By Angela Sanders Wednesday, March 05 2014 @ 01:23 AM EST
Unarguably the largest market operating today, the foreign exchange market has a daily average trade volume of $1.9 trillion dollars. Having such large amounts of money being traded through the exchange gives it the volatility and liquidity that attracts both short-term traders and long-term investors. But what exactly is Forex? And how can one use it to supplement full-tine income or add to his/her current investment portfolio?
What is Forex?
Foreign exchange is the buying and selling of currencies. There are 8 major currencies popularly traded including the US Dollar, Japanese Yen, British Pound, European Euro, Australian Dollar, New Zealand Dollar, Swiss Franc, and the Canadian Dollar. Unlike stocks or bonds where you buy a single asset, trading the Forex involves buying one currency and selling another. This is why currency pairs are traded rather than single currencies.
For example, if you wish to go long EUR/USD, then you'll have to sell US dollars to buy European Euro. If Euro does increase in value against Uncle Sam, then you profit. If it goes the other way, you lose money. Traders place their bets on the currency they think will weaken or strengthen based on technical indicators or fundamental alterations.
Leverage: A Friend or Enemy?
Leverage refers to the borrowing of money to increase your total buying power and the notional value of your assets. Leverage is a financial tool used in all market types including stocks, futures, options, and of course Forex. The amount of leverage you can use depends primarily on your broker of choice and your risk management rules.
To put this in a clearer perspective, say you had only $1,000 worth of starting capital on your trading account. The broker you are trading with allows a leverage of 50:1. This means you can trade $50,000 worth of assets with only a $1,000 margin. Thus, it increases your potential profits on the given trade. Obviously, however, it also increases your potential losses in the event that price goes against your bias or position.
What is PIP?
PIP is the official measurement of price in Forex. It is the smallest price movement and can vary in value depending on the lot size you are trading. If a currency pair moves from 0.0099 to 0.0100, then it has moved 1 pip. If you are holding a standard lot, you would have profited/lost $10, but if you were holding a mini lot, you would have only lost $1. Pip value can be manually calculated by looking at the exchange rate of the two currencies being traded or by using an online PIP value calculator. Your broker will most likely provide such feature on their website, such as iForex help center.
How Spreads Work
In a nutshell, a spread is the difference between the buy price and sell price. If you are using a non-dealing desk broker service, you will have to pay the spread the broker makes as commission for every trade you put on. For a dealing desk type transaction, you will be paying a fixed commission instead of the spread. There are certain pros and cons for each transaction type and should be carefully considered and based on one's trading style.
Opening and Closing Trades
Most trading platforms are designed to be user-friendly and easily navigable. Opening and closing of trades can be done in a click of the mouse button. In MetaTrader 4, one of the most popular Forex trading platforms, you simply need to press the F9 key and click Open or Close.
The world of Forex is a multifaceted arena, and succeeding will demand more than merely learning the basic terminologies involved. Nonetheless, sound knowledge of trading jargon will provide a more solid footing in the financial niche.