The Forex market is filled with strange phrases, acronyms, and jargon that might leave us scratching our heads.
When using new platforms like MT4, MT5, and others, getting acclimated to trading might be difficult enough. When it comes to trading, unfamiliar terminology and a lack of understanding can be a major roadblock to a trader’s success.
#1 Currency
The world’s currencies are traded on the Forex market. But let’s start with the very basics – What is a currency?
The word currency is derived from the Latin word “currens”, which means “running” or “in circulation.” A currency is money used as a medium of circulation, such as banknotes and coins. Some sources refer to currencies as a system of money used among people in a nation.
Currently, the United Nations recognizes 180 currencies that are used in 195 nations around the world. The US dollar, the Euro, the British pound, and the Japanese yen are all examples of currencies that serve as a store of value and are traded on the worldwide foreign exchange market (Forex).
Just like other assets, the forces of supply and demand determine the value of a currency relative to another currency. Increased supply of a currency sinks its value, while increased demand pushes its value up.
#2 Currency Pair
How we trade these currencies is based on one currency’s performance against another – Forex Trading.
When selecting a currency to trade, you will notice that these come in pairs. Let us use EUR/USD as a case study.
If you were to ‘buy’ EUR against USD, you would be betting that the Euro is going to perform more strongly than the US Dollar.
Pairs are categorized into 3 core groups:
Major Pairs – The 8 common pairs all of which contain USD as the base currency or counter currency and one of the following – EUR, CAD, GBP, CHF, JPY, AUD, NZD.
Cross Pairs – These are any 2 major currencies which do not contain the US Dollar as the base or counter currency. These are deemed more volatile than Major Pairs.
Examples include GBP/AUD, EUR/CAD, and NZD/CAD to name a few.
Exotics – These are quite literally exotic currencies, lesser well-known currencies which can be extremely volatile in the market. These include South African Rand, Hungarian Forint and Polish Zloty.
#3 Major pairs/Minor Pairs
In general, currency pairs can be grouped into major pairs, cross pair, and exotic pairs. Major pairs are currency pairs that include the US dollar as either the base currency or counter-currency and one of the other seven major currencies (EUR, CAD, GBP, CHF, JPY, AUD, NZD.)
If you’re just beginning with trading, you should focus on the major pairs since they usually offer very low transaction costs and enough liquidity to avoid high slippage. Examples of major pairs are EUR/USD, GBP/USD and USD/CHF.
#4 Cross pairs and exotics
Cross pairs, on the other hand, include any two major currencies except the US dollar. Unlike major pairs, cross pairs have higher transaction costs and, at times of lower liquidity, traders can face slippage. Cross pairs are also usually more volatile than major pairs. Examples of cross pairs include EUR/GBP, EUR/CHF and AUD/NZD.
Finally, exotic pairs include exotic currencies which are not in the Top 10 of the most traded currencies, such as the Mexican peso, Turkish lira or Czech koruna. Since those currencies can be extremely volatile, they should be left to be traded by the pros.
#5 Exchange Rate
The exchange rate of a currency pair is what all traders follow. The exchange rate is often simply called the price, since it shows the price of the base currency expressed in terms of the counter-currency. For example, if the exchange rate of EUR/USD is 1.15, this means that one euro costs $1.15, or it takes $1.15 to buy one euro.
A rise in the exchange rate of a currency pair indicates that either the base currency or the counter-currency is appreciating against the base currency. A decrease in the exchange rate indicates that the base currency is losing value against the counter-currency or that the counter-currency is gaining value against the base currency.
#6 Bid/Ask price
Each currency pair has two exchange rates or prices at any one time: the bid price and the ask price. What is the distinction between the two? The bid price is the amount at which buyers are willing to pay to purchase something, whereas the ask price is the amount at which sellers are willing to sell something.
Given its nature, the bid price is always lower than the ask price. Once those two prices meet, either when sellers lower their ask price to meet a buyer’s bid price or when buyers increase their rate they’re willing to pay for a currency and meet a seller’s ask price, a transaction occurs.
In the end, buyers buy at the ask price, and sellers sell at the bid price. This means that each price plotted on your chart represents the market equilibrium at that point of time – the price at which the majority of market participants are willing to transact.
#7 Spread
Each time you enter into a trade, you have the pay transaction costs for that trade. While most brokers don’t charge commissions and fees on placing trades nowadays, the bid/ask spread remains the main cost to Forex traders. When bulls buy at the ask price (the price at which sellers are willing to sell), their position is immediately in a loss that equals the bid/ask spread.
If you’re a day trader or scalper, you need to pay attention to the bid/ask spread since it can eat a large portion of your profits at the end of the day. Swing traders and position traders who have a longer-term approach to trading are less affected by the spread as they open a smaller number of positions and have relatively higher profit targets.
#8 Pip
When Forex traders talk about profits or losses, they usually use the term “pips”. A pip is short from Percentage in Point and represents the smallest increment that an exchange rate can move up or down. Usually, one pip equals to the fourth decimal of most currency pairs.
For example, if EUR/USD is currently trading at 1.1558 and rises to 1.1562, that rise would equal to a change of 4 pips. However, some currency pairs have their pips located at the second decimal place, mostly yen-pairs. If USD/JPY currently trades at 110.25 and falls to 110.10, that fall would equal to a change of 15 pips.
#9 Pipette
A pip represents the fourth decimal place of most currency pairs, but there is an even smaller increment that prices can change. It’s called a pipette and equals 1/10 of a pip, i.e. 10 pipettes are one pip. A pipette is located at the fifth decimal place of most pairs (in yen-pairs, they’re at the third decimal place.)
Most traders don’t follow movements in pipettes, even though some brokers use them in their trading platform. Today, pipettes are mostly used to measure the bid/ask spread, where a tenth of a pip is needed. For example, the spread in EUR/USD might be 1.4 pips, or one pip and four pipettes.
#10 Going long/short
You’ve probably heard about going long or short in a currency pair. Going long simply means to buy, while going short means to sell. In equity markets, most traders are long in anticipation of rising prices. However, in derivative markets, such as options and futures, there is always an equal number of longs and shorts in the market, because each new contract that is bought needs a corresponding seller who needs to go short, and vice-versa.
Since retail Forex is mostly traded with CFDs, traders are able to bet both on rising prices and falling prices. When buying, they’re going “long”, and when short-selling, they’re going “short”.
#11 Support
Support and resistance are one of the most important concepts in technical analysis. Technical traders analyze only price-moves as they believe that the price reflects are available fundamental information, and support and resistance trading plays an important role in that analysis.
The markets are made of crowds of people that speculate, hedge, trade, invest or gamble in the markets. Since people have memory, they remember certain price-levels where the price had difficulties to break below in the past.
They place their buy orders around those levels, as they believe that the price will again fail to break below. This is how support levels are formed. In other words, a support level is a previous low at which the price has a large chance to retrace and move up.
#12 Resistance
Just like support levels, resistance levels are also a crucial tool in a technical trader’s toolbox. While support levels are based on previous lows, resistance levels track previous highs at which the price had difficulties to break above.
Traders remember those levels and place their sell orders around them, as they believe that those levels will again provide selling pressure and move the price down. Since fresh memory is more important than old memory, recent support and resistance levels usually have a higher importance than old support and resistance levels.
#13 Leverage
The Forex market is open around the clock and offers traders to profit not only on rising prices, but also on falling ones. However, there is another reason why a large number of traders feel attracted to the Forex market – leverage.
Trading on leverage allows traders to open a much larger position size than their initial trading account size would otherwise allow, and the Forex market is known for extremely high leverage ratios offered by retail brokers.
Summary
As you’ve seen, the world of Forex trading is full of technical words and acronyms.
As traders, we should continually be reading, learning, and expanding our knowledge in order to become more well-rounded traders and hence more profitable.
The dumbest question is the one that never gets asked. So the next time you’re on a trading forum and come across some terminology you’re unfamiliar with, ask, research, and learn!
Trading forex can be a difficult beast to master, but with the correct tools and instruction, we can continue to improve as traders.
Related
