Impress Your Date With Forex Trading Lingo
By Scottie Pippin, Thu Dec 8th
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As in any new skill that you learn, you need to learn thelingo...especially if you wish to woo your love's heart. You,the newbie, must know certain terms like the back of your handbefore making your first trade. Some of these terms you'vealready learned, but it never hurts to have a little review.
Major and Minor Currencies
The seven most frequently traded currencies (USD, EUR, JPY,GBP, CHF, CAD, and AUD) are called the major currencies. Allother currencies are referred to as minor currencies. Do notworry about the minor currencies, they are for professionalsonly. Actually, on this site we will only be covering what wecall the Fab Five (USD, EUR, JPY, GBP, and CHF). These pairs arethe most liquid and are the only currencies we actually trade.
Cross Currency
A cross currency is any pair in which neither currency is theU.S. dollar. These pairs exhibit erratic price behavior sincethe trader has, in effect, initiated two USD trades. Forexample, initiating a long (buy) EUR/GBP is equivalent to buyinga EUR/USD currency pair and selling a GBP/USD. Cross currencypairs frequently carry a higher transaction cost. The three mostfrequently traded cross rates are EUR/JPY, GBP/EUR, andGBP/JPY.
Base Currency
The base currency is the first currency in any currency pair.It shows how much the base currency is worth as measured againstthe second currency. For example, if the USD/CHF rate equals1.6350, then one USD is worth CHF 1.6350. In the Forex markets,the U.S. dollar is normally considered the "base" currency forquotes, meaning that quotes are expressed as a unit of $1 USDper the other currency quoted in the pair. The primaryexceptions to this rule are the British pound, the Euro, and theAustralian dollar.
Quote Currency
The quote currency is the second currency in any currencypair. This is frequently called the pip currency and anyunrealized profit or loss is expressed in this currency.
Bid Price
The bid is the price at which the market is prepared to buy aspecific currency pair in the Forex market. At this price, thetrader can sell the base currency. It is shown on the left sideof the quotation.
For example, in the quote EUR/USD 1.2812/15, the bidprice is 1.2812. This means you can sell on U.S. dollar for1.2812 Euros.
Ask Price
The ask is the price at which the market is prepared to sell aspecific currency pair in the Forex market. At this price, youcan buy the base currency. It is shown on the right side of thequotation.
For example, in the quote EUR/USD 1.2812/15, the askprice is 1.2815. This means you can buy one U.S. dollar for1.2815 Euros. The ask price is also called the offer price.
The spread is the difference between the bid and ask price. The"big figure quote" is the dealer expression referring to thefirst few digits of an exchange rate. These digits are oftenomitted in dealer quotes. For example, the USD/JPY rate might be118.30/118.34, but would be quoted verbally without the firstthree digits as "30/34".
Quote Convention
Exchange rates in the Forex market are expressed using thefollowing format:
Base currency / Quote currency Bid / Ask
Transaction Cost
The critical characteristic of the bid/ask spread is that it isalso the transaction cost for a round-turn trade. Round-turnmeans both a buy (or sell) trade and offsetting sell (or buy)trade of the same size in the same currency pair. In the case ofthe EUR/USD rate of 1.2812/15,
the transaction cost is threepips.
The formula for calculating the transaction cost is:
Transaction cost = Ask Price - Bid Price
Pip
A pip is the smallest unit of price for any currency. Nearlyall currency pairs consist of five significant digits and mostpairs have the decimal point immediately after the first digit,that is, EUR/USD equals 1.2538. In this instance, a single pipequals 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.
One notable exception is the USD/JPY pair where a pip equals$0.01.
Margin
When you open a new margin account with a Forex broker, youmust deposit a minimum amount with that broker. This minimumvaries from broker to broker and can be as low as $100 to ashigh as $100,000.
Each time you execute a new trade, a certain percentage of theaccount balance in the margin account will be earmarked as theinitial margin requirement for the new trade based upon theunderlying currency pair, its current price, and the number ofunits traded (called a lot). The lot size always refer to thebase currency.
For example, let's say you open a mini-account which provides a200:1 margin or .5% margin. Mini-accounts usually trademini-lots which are $10,000. So if you were to open onemini-lot, instead of having to provide the full $10,000, youwould only need $50 ($10,000 x .5 = $50).
Leverage
Leverage is the ratio of the amount used in a transaction tothe required security deposit (margin). It is the ability tocontrol large dollar amounts of a security with a relativelysmall amount of capital. Leveraging varies dramatically withdifferent brokers, ranging from 10:1 to 400:1.
Margin+ Leverage = Possible Deadly Combination
Trading currencies on margin lets you increase your buyingpower. If you have $5,000 cash in a margin account that allows100:1 leverage, you could purchase up to $500,000 worth ofcurrency because you only have to post one percent of thepurchase price as collateral. Another way of saying this is thatyou have $500,000 in buying power.
With more buying power, you can increase your total return oninvestment with less cash outlay. But be careful, trading onmargin magnifies your profits AND losses.
MarginCall
All traders fear the dreaded margin call. This occurs when yourbroker notifies you that your margin deposits have fallen belowthe required minimum level because an open position has movedagainst you.
Trading on margin can be a profitable investment strategy, butit is important that you take the time to understand the risks.You should make sure you fully understand how your marginaccount works. Be sure to read the margin agreement between youand your broker. Talk to your broker if you have anyquestions.
The positions in your account could be partially or totallyliquidated should the available margin in your account fallbelow a predetermined threshold. You may not receive a margincall before your positions are liquidated (the ultimateunexpected birthday gift).
Margin calls can be effectively avoided by monitoring youraccount balance on a very regular basis and by utilizingstop-loss orders (discussed later) on every open position tolimit risk. For ease of use, most online trading platformsautomatically calculate the profit and loss your open positions.
About the author:Scottie Pippin is a professor from BabyPips.com's School ofPipsology. BabyPips.com is a free, funny, and easy-to-understandguide for teaching beginners how to trade in the foreignexchange market.
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