Forex Trading 101: What are the most useful Forex Terms and Definitions
Disclaimer: This article has been produced using publicly available content for educational purposes only and does not constitute trading advice or a solicitation to buy or sell any financial instrument.
All exchange rates are made in relation to a currency pair. It is the valuation of one currency against another. For example, the Canadian Dollar and British Pound form into the CAD/GBP. The first currency is the base currency, and the second is the quote currency.
If the CAD/GBP exchange rate is 0.57 then this means that 1 Canadian Dollar is ‘worth’ 0.57 British Pounds. On the flipside, if the GBP/CAD is 1.76 then this means that 1 British Pound can buy you 1.76 Canadian Dollars.
A Japanese candlestick is a visual representation of price movement across a time period (See example below). These simple visuals give you a lot of information. The colour will indicate whether the thing you are tracking has gone up or down - often red will indicate downward movement and green will indicate upward movement. The candlestick also gives us the opening and closing price throughout the time period. The lowest part of the “candle” is the opening price and the highest part of the candle is the closing price. Finally, the highest and lowest points on the candlestick show the absolute highest and lowest price during the time period.
Entry is when someone decides to open (buy or sell) a position. Exit is when someone decides to close their position for a profit or a loss.
A stop loss is a great way to limit your risk and downside. Say you buy an asset and the value starts going down. Theoretically, this could continue to fall until you’ve drained your entire trading account. A stop loss order is a way of automatically cutting your losses. You set the stop loss order at a price which you deem the loss to be unacceptable. This means that you only ever lose as much as the stop loss order you’ve placed specifies.
A take profit order is the complete opposite of a stop loss. This type of order automatically closes your position when you have made a certain amount of profit. This protects you from a position being “in the money” (making a profit) and then dropping back down before you’ve had a chance to take your profit and close the position. Combining both stop loss orders and take profit orders will reduce the amount of time you have to actively watch your positions.
A key trait of Forex trading is the extensive use of leverage. Leverage is when you borrow money from your broker to make trades with more money than you’re actually putting down. Say you want to open a $1000 position, you could do this by using $100 from your trading account and borrowing $900 from your broker (this would be a 10-1 leverage). The advantage of this is that if the position grows 10% then you make 15% on the total position (15% of $1000 = $150) having only put $100 of your own money down. On the flip side, if the position decreases in value then you could lose money very quickly. For example, if the position went down 10% then you will have lost the $100 you put down. Leverage is a great way to improve your gains but be aware of the serious risk that the downside presents.
The Bid price is the highest price that a broker will pay to buy your financial instrument from you. The opposite of bid price is the Ask price. The Ask price is the lowest price a broker will sell the financial instrument to you.
Going short means that you expect the price of something to decrease. In Forex, you are selling one currency against another with the expectation that it’s value will decrease in relation to the other currency in the pair. In the GBP/CAD example, you would sell pounds and buy CAD with the hope that value of the CAD in relation to the GBP will increase. Going long is the exact opposite. You expect the price of the currency to increase against the other.
Simply, this the rate of one currency that you could exchange for another currency. Exchange rates are shown for currency pairs.
The quote is the market price expressed as two figures. The quote will show the bid price and the ask price. For example, GBP/CAD (1.7279, 1.7220) would mean that the bid price is 1.7279 and the ask price is 1.7220.
The currency that your trading account is in.
This is the smallest unit of measuring the change in price. 1 pip is 0.0001. Say the GBP/CAD increases 5 pips then it will have risen by 0.0005. The only exception is with currency pairs involving the Japanese Yen which is only measured to 2 decimal places.
Margin is the minimum amount of funds, expressed as a percentage, that you will need to open a position and keep it open. This ties into the idea of leverage. If you are using a 100-1 leverage then if you want to open a $100 dollar position you will need $1 in your account and this is a 1% margin. If you only had $1 in your account (highly unlikely but useful for illustrative purposes) then if the position decreased by 1% your position would automatically close because you don’t have the funds to cover any more losses.
A lot is the size of the position that you open. The standard lot size is 100,000 of the base currency in the currency pair. If you opened a $10,000 dollar position on the GBP/USD then this would be 0.1 lots.
The spread is the difference between the ask and bid price. You can think of this as the fee for trading. If the actual value is 1.2000 and the ask price is 1.1119 and the bid price is 1.2001 then the spread is 0.0002 (or 2 pips). This is essentially a fee that the brokerage collects for each trade you make.