Understanding Forex

One problem traders experience when entering the Forex market is simply understanding it, because it has a language all of its own: Pips, pairs, bear, futures… it’s gibberish to the average investor. But you don’t have to worry about any of that kind of specialised “lingo”, I’ll tell you what to do in simple, easy to follow language.

Another problem investors have had is figuring out how to research and analyse the factors that influence currency prices. Currencies aren’t like shares or other investments where you can pull up company reports, price to earnings ratios and other critical information at the click of a button.

I’ll show you just how simple it is to trade currency trends straight from your trading account.

But before i do that, i ‘ld like you to get familiar with a few terms.

A few commonly used terms

The trading universe has its own vocabulary, and I encourage you to learn more of these terms.Below are the commonly used terms that you will most likely refer to:

Base currency

The first currency in a 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 1.6215 then one USD is worth CHF 1.6215. In the FX market, the US 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.

Base rate

The lending rate of the central bank of a given country.

Bearish / Bear market

Negative for price direction; favoring a declining market. For example, “We are bearish EUR/USD” means that we think the Euro will weaken against the dollar.

Bid price

The price at which the market is prepared to buy a product. Prices are quoted two-way as Bid/Ask.

In FX trading, the Bid represents the price at which a trader can sell the base currency, shown to the left in a currency pair. For example, in the quote USD/CHF 1.4527/32, the base currency is USD, and the Bid price is 1.4527, meaning you can sell one US Dollar for 1.4527 Swiss francs.

In CFD trading, the Bid also represents the price at which a trader can sell the product. For example, in the quote for UK OIL 111.13/111.16, the Bid price is £111.13 for one unit of the underlying market.*

Bid/ask spread

The difference between the Bid and the Ask (Offer) price.

Big figure

Refers to the first 3 digits of a currency quote, such as 117 USD/JPY or 1.26 in EUR/USD. If the price moves by 1.5 big figures, it has moved 150 pips.

Broker
An individual or firm that acts as an intermediary, bringing buyers and sellers together for a fee or commission. In contrast, a ‘dealer’ commits capital and takes one side of a position, hoping to earn a spread (profit) by closing out the position in a subsequent trade with another party.

Buck

Market slang for 1 million units of a dollar-based currency pair or for the US dollar in general.
Bullish / Bull market

Favoring a strengthening market and rising prices. For example, “We are bullish EUR/USD” means that we think the Euro will strengthen against the dollar.

Bulls

Traders who expect prices to rise and who may be holding long positions.

Buy

Taking a long position on a product.

Buy dips

Looking to buy 20-30-pip/point pullbacks in the course of an intra-day trend.

Call option

A currency trade which exploits the interest rate difference between two countries. By selling a currency with a low rate of interest and buying a currency with a high rate of interest, the trader will receive the interest difference between the two countries while this trade is open.

Candlestick chart

A chart that indicates the trading range for the day as well as the opening and closing price. If the open price is higher than the close price, the rectangle between the open and close price is shaded. If the close price is higher than the open price, that area of the chart is not shaded.

CFDs*

A Contract for Difference (or CFD) is a type of derivative that gives exposure to the change in value of an underlying asset (such as an index or equity). It allows traders to leverage their capital (by trading notional amounts far higher than the money in their account) and provides all the benefits of trading securities, without actually owning the product. In practical terms, if you buy a CFD at $10 then sell it at $11, you will receive the $1 difference. Conversely, if you went short on the trade and sold at $10 before buying back at $11, you would pay the $1 difference.

Clearing

The process of settling a trade.

Closed position

Exposure to a financial contract, such as currency, that no longer exists. A position is closed by placing an equal and opposite deal to offset the open position. Once closed, a position is ‘squared’.

Closing

The process of stopping (closing) a live trade by executing a trade that is the exact opposite of the open trade.

Closing price

The price at which a product was traded to close a position. It can also refer to the price of the last transaction in a day trading session.

Currency
Any form of money issued by a government or central bank and used as legal tender and a basis for trade.

Currency pair

The two currencies that make up a foreign exchange rate, for example EUR/USD.

Currency risk

The probability of an adverse change in exchange rates.

Currency symbols

A three-letter symbol that represents a specific currency, for example USD (US Dollar).

Current account

The sum of the balance of trade (exports minus imports of goods and services), net factor income (such as interest and dividends) and net transfer payments (such as foreign aid). The balance of trade is typically the key component to the current account.
Day trader
Speculators who take positions in commodities and then liquidate those positions prior to the close of the same trading day.

Day trading

Making an open and close trade in the same product in one day.

Derivative
A financial contract whose value is based on the value of an underlying asset. Some of the most common underlying assets for derivative contracts are indices, equities, commodities and currencies.
Divergence

In technical analysis, a situation where price and momentum move in opposite directions, such as prices rising while momentum is falling. Divergence is considered either positive (bullish) or negative (bearish); both kinds of divergence signal major shifts in price direction. Positive/bullish divergence occurs when the price of a security makes a new low while the momentum indicator starts to climb upward. Negative/bearish divergence happens when the price of the security makes a new high, but the indicator fails to do the same and instead moves lower. Divergences frequently occur in extended price moves and frequently resolve with the price reversing direction to follow the momentum indicator.

Downtrend

Price action consisting of lower-lows and lower-highs.

Fair value

The difference between the price of a derivative contract and the underlying cash market price. Fair value means there are no arbitrage opportunities between the two prices.

Future
An agreement between two parties to execute a transaction at a specified time in the future when the price is agreed in the present.

Futures contract

An obligation to exchange a good or instrument at a set price and specified quantity grade at a future date. The primary difference between a Future and a Forward is that Futures are typically traded over an exchange (Exchange- Traded Contacts – ETC), versus Forwards, which are considered Over The Counter (OTC) contracts. An OTC is any contract NOT traded on an exchange.
Gap / Gapping
A quick market move in which prices skip several levels without any trades occurring. Gaps usually follow economic data or news announcements.

Gearing (also known as leverage or margin)

Gearing refers to trading a notional value that is greater than the amount of capital a trader is required to hold in his or her trading account. It is expressed as a percentage or a fraction.

Going long
The purchase of a stock, commodity or currency for investment or speculation – with the expectation of the price increasing.

Going short

The selling of a currency or product not owned by the seller – with the expectation of the price decreasing.

Guaranteed order
An order type that protects a trader against the market gapping. It guarantees to fill your order at the price asked.

Guaranteed stop

A stop-loss order guaranteed to close your position at a level you dictate, should the market move to or beyond that point. It is guaranteed even if there’s gapping in the market.

Knock-ins
Option strategy that requires the underlying product to trade at a certain price before a previously bought option becomes active. Knock-ins are used to reduce premium costs of the underlying option and can trigger hedging activities once an option is activated.

Knock-outs

Option that nullifies a previously bought option if the underlying product trades a certain level. When a knock-out level is traded, the underlying option ceases to exist and any hedging may have to be unwound.
Leading indicators
Statistics that are considered to predict future economic activity.

Level

A price zone or particular price that is significant technically or based on reported orders/option interest.

Leverage

Also known as margin, this is the percentage or fractional increase you can trade from the amount of capital you have available. It allows traders to trade notional values far higher than the capital they have. For example: leverage of 100:1 means you can trade a notional value 100 times greater than the capital in your trading account.*

Leveraged names

Short-term traders, referring largely to the hedge fund community.

Limits / Limit order
An order that seeks to buy at lower levels than the current market or sell at higher levels than the current market. A limit order sets restrictions on the maximum price to be paid or the minimum price to be received. As an example, if the current price of USD/YEN is 117.00/05, then a limit order to buy USD would be at a price below the current market, e.g. 116.50.

Liquid market
A market which has sufficient numbers of buyers and sellers for the price to move in a smooth manner.

Long position
A position that appreciates in value if market price increases. When the base currency in the pair is bought, the position is said to be long. This position is taken with the expectation that the market will rise.

Market maker
A dealer who regularly quotes both bid and ask prices and is ready to make a two-sided market for any financial product.

Market order

An order to buy or sell at the current price.

Market risk

Exposure to changes in market prices.

Mark-to-market

Process of re-evaluating all open positions in light of current market prices. These new values then determine margin requirements.

Maturity

The date for settlement or expiry of a financial product.

Offer (also known as the Ask price)
The price at which the market is prepared to sell a product. Prices are quoted two-way as Bid/Offer. The Offer price is also known as the Ask. The Ask represents the price at which a trader can buy the base currency, which is shown to the right in a currency pair. For example, in the quote USD/CHF 1.4527/32, the base currency is USD, and the ask price is 1.4532, meaning you can buy one US dollar for 1.4532 Swiss francs.

In CFD trading, the Ask represents the price a trader can buy the product. For example, in the quote for UK OIL 111.13/111.16, the product quoted is UK OIL and the ask price is £111.16 for one unit of the underlying market.*
Open position
An active trade with corresponding unrealized P&L, which has not been offset by an equal and opposite deal.

Option

A derivative which gives the right, but not the obligation, to buy or sell a product at a specific price before a specified date.

Pair
The forex quoting convention of matching one currency against the other.

Pips
The smallest unit of price for any foreign currency, pips refer to digits added to or subtracted from the fourth decimal place, i.e. 0.0001.
Portfolio

A collection of investments owned by an entity.

Position

The net total holdings of a given product.

Short position
An investment position that benefits from a decline in market price. When the base currency in the pair is sold, the position is said to be short.

Spot market
A market whereby products are traded at their market price for immediate exchange. Spot price
The current market price. Settlement of spot transactions usually occurs within two business days. Spot trade
The purchase or sale of a product for immediate delivery (as opposed to a date in the future). Spot contracts are typically settled electronically.
Spread

The difference between the bid and offer prices.

Stop order
A stop order is an order to buy or sell once a pre-defined price is reached. When the price is reached, the stop order becomes a market order and is executed at the best available price. It is important to remember that stop orders can be affected by market gaps and slippage, and will not necessarily be executed at the stop level if the market does not trade at this price. A stop order will be filled at the next available price once the stop level has been reached. Placing contingent orders may not necessarily limit your losses. Stop entry order
This is an order placed to buy above the current price, or to sell below the current price. These orders are useful if you believe the market is heading in one direction and you have a target entry price.
Stop loss order

This is an order placed to sell below the current price (to close a long position), or to buy above the current price (to close a short position). Stop loss orders are an important risk management tool. By setting stop loss orders against open positions you can limit your potential downside should the market move against you. Remember that stop orders do not guarantee your execution price – a stop order is triggered once the stop level is reached, and will be executed at the next available price.

Technical analysis
The process by which charts of past price patterns are studied for clues as to the direction of future price movements.

Trailing stop
A trailing stop allows a trade to continue to gain in value when the market price moves in a favorable direction, but automatically closes the trade if the market price suddenly moves in an unfavorable direction by a specified distance. Placing contingent orders may not necessarily limit your losses.
Trend

Price movement that produces a net change in value. An uptrend is identified by higher highs and higher lows. A downtrend is identified by lower highs and lower lows.

Unrealized gain/loss
The theoretical gain or loss on open positions valued at current market rates, as determined by the broker in its sole discretion. Unrealized Gains/Losses become Profits/Losses when the position is closed.

Yield
The percentage return from an investment.

References used for glossary of terms-forex.com and fspinvest.co.za