Forex terminology can be somewhat tricky. There are all sorts of technical terms, fancy language and animal-themed phrases that might be confusing to the amateur trader.
Don’t despair, however. Here’s a quick guide that will cover many of these and educate you on the Forex lingo.
Base & Quote
Currencies are always priced in pairs. For example, USD/JPY.
The first currency is the Base and the second is the Quote or Counter Currency.
The price we see in the image above tells us how much of the quote (yen) we need to get one unit of the base (dollar). In this case, one USD will get us about 108 JPY and 2 cents.
So if we decide to buy at the price shown, we’re hoping that this price will go up and we end up getting more ¥ for our $. We want the dollar to gain strength for the price to go up. If the price went up from, say, 108 to 109, we would get more ¥ for our $ and, therefore, the dollar has strengthened.
If the price went down to 107, we’d be getting 107 yen for a dollar. So, we’re getting fewer yen than we were before and, therefore, the dollar has weakened.
In the image above, we also notice something called Pip Value.
A Pip, or point in percentage, is the shortest recognized move in a currency price.
So, if we look at the USD/JPY price again at 108.02, if it moves to 108.03, then we would say that the USD/JPY has moved up by one pip.
Keep in mind that yen pairs only show two decimal places because cents are not really used in Japan anymore. Things are priced in yen, making the smallest incremental move 1 yen.
A pip is always a hundredth of the smallest incremental move. Most other pairs, say, EUR/USD or GBP/USD, are quoted in four decimal places. So if we focus on the large numbers, the base currency of the EUR/USD (in this case, the euro) tells us how many dollars we get for 1 euro. In the image above, 1 EUR gives us 1 USD and 10 cents.
Some brokers may quote EUR/USD with five decimal places instead of four. That fifth decimal place is just a fraction of a pip and they do this to give us a tighter spread and better price.
But remember that the pip value is always going to be based on the fourth decimal number because that is a hundredth of the smallest incremental move on the dollar and that would be a cent. Brokers also do this with yen pairs, but use two decimals instead of two.
Long vs. Short (Buy vs. Sell)
Long and short basically describe the direction of a new trade.
For example, if we mention going long on USD/JPY, it means we’re buying USD/JPY.
Alternatively, if we mention going short on USD/JPY, it means that we’re selling the USD/JPY price. If we were already long on USD/JPY and wanted to take profit or loss, then we would be selling to close the trade. Going short means we’re carrying out a separate new trade altogether.
Bid vs. Offer
When an asset is priced, we will always hear two prices. The first is the price to sell and the second is the price to buy.
The lower of the two is the Bid, or the selling price, and the higher of the two is the Ask or the Offer to buy price.
Back to the example above, USD/JPY is given in two prices, 108.00 and 108.02. The bid price is 108.00 and the ask or offer price is 108.02.
The difference between the bid and the ask is what is known as the Spread.
Leverage & Margin
When trading in Forex, we have Margin, which means that we need to have a certain amount of money in our trading account to be able to take a trade.
Leverage, on the other hand, is offered to us by the broker to allow us to take a trade that is a hundred times the size of our trading account. This can happen as long as we have a small deposit or margin deposited in our account.
It’s a bit like when buying a house. To buy a house, we don’t need the whole value of the house upfront. Instead, we normally put down a deposit and borrow the rest from the bank. In Forex, this is called leveraging of the broker and it’s like we’ve borrowed from the broker.
Is that a good thing? Yes and no!
Let’s try and explain this with the house analogy. Person A buys a house for $100,000. He has the amount in cash because he’s a very good saver. Person B buys a house, also for $100,000, but he’s only got $50,000 in cash. So he gets a loan from the bank for the remaining $50,000 and buys the house next door.
A few years later, both houses go up in value and now cost $200,000. Person A invested $100,000 and now has $200,000, doubling his initial investment.
Now, this is what leverage can do. Person B, who only invested $50,000, now has a house worth $200,000. Yes, Person B still has a loan at the bank that he’s paying off. But the point is that B has quadrupled his initial investment of $50,000. The bank loan will eventually get paid with the interest, but B has quadrupled his money whereas A has only doubled it.
How does this work in Forex?
Well, let’s have a look.
In our example, we have $5,000 in the account. We trade from this account with a leverage of $100,000 from the broker.
Leverage can work in either a good or bad way for us.
If it goes well and we make a 5% profit from $100,000, then we end up with a $5,000 gain in our trading account.
On the contrary, if we lose and our losses amount to 5% of $100,000, then we have lost $5,000. That’s our entire margin in the trading account.
This is if we were to take the leverage from the broker.
But if we had traded without any leverage and relied entirely on our $5,000 margin, should we have lost 5%, then we would only lose $250.
That’s a little insight into how, with leverage, we can make and lose money at a faster rate than we would without using leverage.
Leverage is a great thing when you know what to do with it. However, it can be the nail in the coffin for those who have not yet perfected their trading skills, which is probably why we see a very high rate of novice traders blowing their accounts.
Rollover is the time of day when interest is paid to the broker on any positions not closed by 17:00 EST (New York time).
Usually, it’s a very minuscule amount when we consider the advantages of trading with such huge amounts of money. The rollover depends on something called the nterest Rate Differential. This is the difference between an interest rate in one country compared to that in another country.
In the image above, we’ve got Japan and the US. Let’s say we sold USD/JPY. In the US, we’ve got a base rate of 1.75, while in Japan it’s zero. So we have to pay 1.75 per year on, say, $100,000 that you trade.
Now, we’re not holding the trade for the entire year. So we are only going to pay the overnight rate, which is roughly speaking divided by 365 and multiplied by the base exchange rate. The Forex broker will calculate this for you and they will automatically take the interest out of your account.
So if we are trading $100,000, we will probably be paying something like $4 or $5 dollars in interest.
There is a way of getting out of paying this interest. If we were to close the trade before 17:00 EST (New York time), then we would not have to pay any interest because at that time we did not have a trade open. So there’s no need for rollover.
Now make a note of this: Sometimes we don’t end up paying any interest but we might end up earning interest.
How is this possible?
If we buy USD/JPY, then we receive 1.75% annually and we pay whatever the yen interest rate is. We don’t have to pay any interest on the yen because we’re borrowing in yen.
We know the interest rate in Japan is zero (minus 0.1 actually) and there’s nothing to pay on the other side. So this is the beauty of Forex. With just $5,000, we can buy $100,000 worth of USD/JPY and receive interest on $100,000 daily on the overnight rate for as long as we keep the trade open.
Your trading platform will tell you exactly what the interest payment is that you will receive if you leave the trade to just roll over at 17:00 EST (New York time).
The Carry Trade
Years ago, there was something called the Carry Trade, a very popular strategy in Forex.
Under this strategy, traders and financial institutions would hold large positions in AUD/JPY or CAD/JPY and receive large interests on those commodity currencies. This would leave these funds with a net interest surplus, obviously depending on how much money they would have under management.
Nowadays, this type of strategy is carried out only with emerging market currencies, which pay a higher interest rate. So, we have Mexican peso, Turkish lira and South African rand, which are traded against the likes of the Euro, which has a very low, almost zero interest rate.
Bulls & Bears
Bulls and bears. What are they? What does this mean?
Many of us have heard the term probably on television describing the market as Bullish or Bearish.
It’s not complicated. Bullish means going up and bearish going down.
If we’re bull, then we think the market is going to strengthen. On the other hand, if we hear that the bears have taken over the market, it means the market is now turning from up to down.
So we use the terms bull and bear to describe the sentiment or attitude of the market or a particular trader.