Lesson 05-Currency trading terms

Trading Hours

With only a short break on the weekend, forex trading takes place 24 hrs per day. With the increased use of global high speed Internet connections and 24 hour trading, the forex market is an almost constant activity centre.

A Few Forex Terms

Everyone trading forex needs to know the basic terms listed below to get started. For more information, be sure to browse our online glossary.

Foreign Exchange

Foreign exchange, or Forex, is a decentralized global market for buying and selling currencies.

Spot Market, Forwards and Futures Markets

The "spot market" is the largest segment of the forex market, and deals with the current price of currency, and immediate trades. The "forwards market" involves custom designed contracts for independent transactions occurring at a specific future date. The "futures market" involves standard contracts for a future date, under the auspices of an established exchange.

Currency Pair

Two currencies are always involved in a forex trade - one is being bought in exchange for the other. Together, those two currencies are called a currency pair, and are usually represented as two three-letter currency abbreviations. For example, consider the currency pair EUR/USD. In this example, the first currency, the Euro (EUR), is called the Base Currency and the second, the US Dollar (USD) is called the Quote Currency.

For most transactions, either the USD or EUR is used as the base currency. In the case of the example EUR/USD, the value of the USD (the quote currency) is considered in relation to 1 EUR. If the quoted price for this pair is 1.3553, this means that 1 Euro can buy 1.3533 US Dollars.

Here is how that information might be used. If a trader thinks that the value of the US Dollar will decrease in value relative to the Euro, he might buy the EURUSD, currency pair and then later sell the pair for a profit when the value of the pair increases (representing a decrease in the value of the USD, the quote currency) See below for a detailed example of a similar trade. 

Pip

A pip is the smallest unit of price for any currency. It is an abbreviation of Percentage in Point. Most currencies are expressed to the fourth decimal point, and the pip is the smallest change in the fourth decimal place, or 0.0001. This means that for USD, a pip is 1/100th of a cent. The Japanese Yen is the only currency expressed to the second decimal place, making its pip value 0.01. Profits or losses in forex trading are often expressed as pips. 

Bid Price, Ask Price and Spread

Bid and Ask Price

In any forex transaction, one currency is sold at the same time another is bought. Just as in an auction, the foreign exchange market uses the terms Bid and Ask to describe the value of the currency.

A simple rule to remember when considering a forex trade is that you can buy a currency pair at the Ask price, and sell it at the Bid price. It is easy to remember which price is which: the market "Bids" a certain price when it buys a pair from the forex trader, and is "Asks" a certain price when it sells a currency pair to the trader.

The terms Bid and Ask make best sense when considered from the perspective of the Market. The Bid price is the price at which others are willing to purchase a particular currency pair, while the ask price is the price at which others are willing to sell the currency pair.

To restate this important concept in terms of base and quote currencies, the Bid price is the amount the market is offering to buy the base currency, while the Ask is the amount that the market is asking to sell the base currency (in a price denominated by the quote currency).

Forex prices sometimes express both Bid and Ask values in the form Bid/Ask. For example, a USD/CAD forex quote might be expressed as 1.0180/83. This price indicates that the Bid is 1.0180, and the Ask price is 1.0183. 

Spread

Spread is the difference between the Bid and Ask prices. In the case of the USD/CAD forex quote mentioned 1.0180/83, the spread is .0003, often expressed as "3 pips". Forex brokerages often set the spread of currency pairs offered at fixed amounts. For the forex trader, this fixed spread allows for better pricing consistency from trade to trade.

For an example of how this information is used when calculating profit and loss in forex trading, please see the Mechanics of Forex Trading section.

Leverage and Margin

Leverage

Leverage allows a large amount of currency to be bought with a small investment. The amount of leverage available to a trader varies with the broker, for example 100:1, meaning that currency trades worth $100,000 can be made with an investment of $1,000. The word "leverage" originally meant the effect of using a lever to move a much larger object. In forex terms, leverage allows the use of credit to buy more currency with just a small amount of money on deposit. That deposit money is usually called "margin".

Margin

Margin refers to money actually deposited into a forex trading account. A trader must have a certain amount of money, the "margin" in their account before they can trade in the forex market. The amount required relates directly to the amount of leverage available. For example, if a margin account has a value of $1000 and leverage is 100:1, the trader can trade up to $100,000 in foreign currencies. Note that the amount of available margin will increase or decrease as the value of the forex currencies actively traded increase and decrease in value, through a process named "marked to market", through which profits and losses are immediately credited to or deducted from the trader's margin account.