Basic Forex Terminology
At some point, all people who want to become forex traders will need to get themselves some of the most basic education that is required to navigate the Forex market. In this Wiki, we will attempt to give some basic terms and definitions for people that are looking to get a basic understanding of the lingo used by forex participants.
Major and Minor Currencies
The eight most frequently traded currencies are USD, EUR, JPY, GBP, CHF, CAD, NZD, and AUD. These are called the major currencies or the “Majors” and are the most liquid of all currencies. Most other currencies are referred to as minor currencies. However, if the currency is extremely illiquid and thinly traded, these currencies might be referred to as “Exotic.” Examples of exotic currencies include the Thai baht, Uruguay peso or Iraqi dinar.
Base Currency
The base currency is the first currency in any currency pair. The currency quote shows how much the base currency is worth as measured against the second currency. For example, if the USD/JPY rate equals 1.2350, then one USD is worth JPY 1.2350.
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.
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 1.1138. 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.
However, with the Japanese yen a pip equals 0.01 and is typically quoted in 3 decimal places instead of 5.
Long (Buy)
A long position is a bought position. This refers to the direction of the first currency in the pair. For example, if you are long EURUSD, then you have bought euros and sold US dollars.
Short (Sell)
A short position is a sold position. For example, if you are short EURUSD, then you have sold euros and bought US dollars.
Pipette
One-tenth of a pip. Some brokers quote fractional pips, or pipettes, for added precision in quoting rates. For example, if EUR/USD moved from 1.11156 to 1.11157, it moved 1 pipette or a tenth of a pip.
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 GBP/USD 1.5512/15, the bid price is 1.5512. This means you sell one British pound for 1.5512 U.S. dollars.
Ask/Offer Price
The ask/offer 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 1.1112/15, the ask price is 1.1115. This means you can buy one euro for 1.1115 U.S. dollars. The ask price is also called the offer price.
Bid/Ask Spread
The spread is the difference between the bid and ask price. For example, the USD/JPY rate might be 118.30/118.34 which would mean the USD/JPY has a 4-pip spread.
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 a buy (or sell) trade and an offsetting sell (or buy) trade of the same size in the same currency pair. For example, in the case of the EUR/USD rate of 1.1112/15, the transaction cost is three pips.
The formula for calculating the transaction cost is:
Transaction cost (spread) = Ask Price – Bid Price
Cross Currency
A cross currency is any pair in which neither currency is the U.S. dollar. These pairs may 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 GBP/USD. Cross currency pairs frequently carry a higher transaction cost or have larger spreads.
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 set aside as the initial margin requirement for the new trade based upon the underlying currency pair, its current price, and the number of units (or lots) traded. The lot size always refers to the base currency.
For example, let’s say you open a mini account which provides a 200:1 leverage or 0.5% margin. Mini accounts trade mini lots. Let’s say one mini lot equals $10,000. If you were to open one mini-lot, instead of having to provide the full $10,000, you would only need $50 for your margin requirement ($10,000 x 0.5% = $50).
Leverage
Leverage is the ratio of the amount capital 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 2:1 to 1000:1.
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