Basic Forex Terminology

As with every new skill you learn, you must also learn its terminology. There are certain terms that you need to know before you start trading in Forex. Here are the main ones.

[caption id="attachment_478" align="aligncenter" width="401"] Basic Forex Terminology[/caption]

Basic Forex Terminology

 

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The 8 most used currencies (USD, EUR, JPY, GBP, CHF, CAD, NZD and AUD) are known as "major currencies". All other currencies are called "minor currencies." You do not have to worry about the smaller currencies, since you probably will not start trading with them for now. The USD, EUR, JPY, GBP, and CHF currencies are the most popular and most liquid on the market.

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• Base Currency

The base currency is the first currency in any currency pair. It shows how much the base currency is against the second currency. For example, if the USD / CHF has a rate of 1.6350, it means that USD 1 is worth 1.6350 CHF. In the forex market the US dollar is in many cases the base currency to make quotes, the quotes are expressed in units of 1 $ on the other currency of the pair.

In some other pairs the base currency is the British pound, the euro, the Australian dollar or the New Zealand dollar.

• Quoted currency

The quoted currency is the second currency of the currency pair. This is often referred to as "pip-currency" and any unrealized gain or loss is expressed in this currency.

Pip

A pip is the smallest unit of the price of any currency. Almost all currencies consist of 5 significant digits and most pairs have the decimal point immediately after the first digit. For example EUR / USD = 1.2538, in this case a pip is smaller change in the fourth decimal place, that is, 0.0001.

One notable exception is the USD / JPY pair where the pip equals $ 0.01.

• Purchase price (bid)

The bid price is the price at which the market is prepared to buy a specific currency in the Forex market. At this price, one can sell the base currency. The purchase price is shown on the left side.

For example, in the GBP / USD = 1.88112 / 15, the selling price is 1.8812. This means that you can sell a GPB for $ 1,8812.

• Selling price (ask)

At this price, you can buy the base currency. The sale price is shown on the right side.

For example, in EUR / USD = 1.2812 / 15, the selling price here is 1.2815. This means you can buy one euro for $ 1,2815. The selling price is also called the offer price.

• Spread

All quotes in Forex include two prices, bid (bid) and ask (demand).

The bid is the price at which the broker is willing to buy the base currency in exchange for the quoted currency. This means that bid is the price at which you can sell.

This means that ask is the price at which you will buy. The difference between bid and ask is popularly known as the spread and is the consideration that the online broker receives for its services.

• Transaction costs

The transaction cost, which could be said to be the same as the spread, is calculated as: Transaction Cost = Ask-Bid. It is the number of pips that are paid when opening a position. The final amount also depends on the size of the operation.

It is important to note that depending on the broker and the volatility, the difference between ask and bid can increase, making it more expensive to open an operation. This generally happens when there is a lot of volatility and little liquidity, as it happens during the announcement of some relevant economic data.

• Cross currency

A cross currency is any pair where one of the currencies is the US dollar (USD). These pairs show an erratic behavior of the price, when the operator opens two operations in American dollars. For example, opening a long EUR / GPB purchase is equivalent to buying EUR / USD and selling GPB / USD. Cross currency pairs usually carry a higher transaction cost.

• Margin

When you open a new margin of account with a Forex broker, you must deposit a minimum amount of money to your broker. This minimum varies depending on each broker and can be as low as 100 € / $ to higher amounts.

Each time a new operation is executed, a percentage of your account's margin balance will be the initial margin required for a new transaction based on the underlying currency pair, the current price, and the number of units (or lots) of the transaction .

For example, suppose you open a mini account which gives you a leverage of 1: 200 or a margin of 0.5%. Mini accounts work with mini lots. Suppose a mini lot equals $ 10,000. If you are about to open a mini lot, instead of having to invest $ 10,000, you will only need $ 50 ($ 10,000 x 0.5% = $ 50).

• Leverage

Leverage is the proportion of capital used in a transaction for the required deposit. It is the ability to control large amounts of dollars with relatively smaller capital. Leverage varies drastically according to the broker, can range from 1: 2 to 1: 2000. The most frequent level of leverage in Forex can currently be around 1: 200.

• Margin + Leverage = Dangerous Combination

Trading currencies with a margin allows you to increase your purchasing power. This means that if you have $ 5,000 in a margin of account that allows you a leverage of 1: 100, you can then buy $ 500,000 in hard currency since you only have to invest a percentage of the purchase price. Another way of saying this, is that you have $ 500,000 in purchasing power.

With more purchasing power you can greatly increase potential profits without cash outlay. But be careful, working at a high margin increases your profits but also your losses if the operation does not advance in your favor.

In addition to these basic terms, we recommend that you take a look and have this forex glossary with more terms that you will need to know later: Forex Glossary.

NOTE: This article is not an investment advice. Any references to historical price movements or levels is informational and based on external analysis and we do not warranty that any such movements or levels are likely to reoccur in the future.