Banking and Finance

Forex Trading Terminologies You Need To Know

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It is common practice for every industry to have its own unique language. Medical practitioners have their own language, so is the security industry, and the political industry.

This is a language that is only useful and understandable by the people in that industry. Forex trading is no different and thus there are specific words and terminologies that you will encounter when you start trading.

These words allow the participants in this industry to communicate hence creating understanding and uniformity.

Currency Pair

Currencies are traded in pairs. A currency pair is the value in which currencies are quoted. This is a key term to note because you will find and use it as long as you are in Forex business.

An example of a currency pair is the EUR/USD. I have used this pair because it is the most traded in Forex trading. Positioning of these pairs determines what you are buying and what you are selling any time you make a trade.

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The first currency is called the Base currency while the second currency is known as the Quote currency. In this case of EUR/USD, EUR= Base Currency While USD=Quote currency.

Currency pairs are divided into various groups depending on their strengths and demand in the market. The popularity of any currency pair has a relationship with the underlying countries economy.  Currency pairs are divided into three as below

  1. Major pairs
  2. Minor pairs
  3. Exotic pairs

Long/Short

In Forex trading, terms buy or sell have their synonyms. Traders use the term going long and going short.  Going long is the same as buying while going short is the same as selling. As I said, every industry has its language.

Leverage

Leverage is the term used to describe borrowing money from the broker enabling you to enter a bigger position. This is quite a common practice, but the amount of leverage differs between brokers.

Normally, leverage is given as a multiplier. An example is a multiplier of 100. This means that the trader is able to trade with an amount 100 times his margin.

Leverage is key when coming up with a trading strategy and establishing credible risk management levels. It is necessary to understand that the same way leverage increases your chances of making more, if the trade goes wrong, it increases the chances of losing more as well.

Margin

Margin is simply the money a trader needs to open a position in the market. By a position I mean if you want to go long or short, then you need a certain amount of money to do so.

Key thing to note is that a margin is not a fee or a cost to you. The margin also determines the amount of leverage you can get. The other key role of a margin is to ensure you have enough funds to cover your losses if the trade goes against you.

The amount of margin required differs based on the currency pair you are trading and the Forex broker you are using. In most instances, margin is usually given in percentages.

The term mostly used for a percentage margin is “margin requirement” The percentage is usually based on your account size. Account size is the total amount of money in your trading account.

PIP

The term PIP in full is Percentage in Point. Currency pairs are usually calculated into 4 decimal places. Thus, one PIP represents .0.0001 of a currency pair.

For calculation purposes, 1 PIP is 1/100 of 1% of a currency. Maybe you are wondering why it is important to understand about pips! Let me explain.

PIPS are the points we use to calculate our profits and losses. When coming with a trading strategy, it is relevant to specify your stop profit and stop loss points.

To do this effectively, you use the PIPS. As an example, you can set to exit the market if you lose 50 pips or if you make 150 pips. This means that you are using a Risk Reward Ratio (RRR) of 1:3. Hence, for every PIP you lose, you expect to make 3 PIPS.

These terms might seem hard to master but this is the only way to becoming a professional trader. There is one currency that has exception to this rule. The JPY (Japanese Yen). JPY IS Usually denoted into 3 decimal places and not the usual 4dp.

Lot size

Lot size in Forex trading denotes the number/amount of currency units you want to buy or sell. This works like a box of chocolate.

Depending on where you come from, you may find that one box contains a specific number of chocolates, example 10. This box represents a lot size of chocolates.

The choice of a lot size determines the amount of currency pairs you are buying or selling. There are different types of Lot sizes used in Forex trading indicated as below.

  • Standard lot
  • Mini lot
  • Micro lot
  • Nano lot

Refer to the below table for a deeper breakdown on Lot sizes. Lot sizes go in tandem with the PIPS.I had explained earlier that a PIP is the smallest unit of measurement in currency.

I have included the breakdown of how much money you earn/lose per dollar depending on you lot size choice.

TYPES OF LOT SIZES
NAMESIZEUNITSPIP/DOLLAR
STANDARD LOT1100,000$10
MINI LOT0.110,000$1
MICRO LOT0.011,000$0.10
NANO LOT0.001100$0.01

Stop Loss

Stop loss refers to the amount of loss a trader is willing to take in case the trade does not go as expected. In Forex trading, the market will not always as be predicted.

Some trades end up as losses arising the need for a stop loss. A stop loss is part of a trading strategy. A successful trader will always have a trading strategy that defines their trading rules.

A stop loss is directly related to the risk reward ratio. Having a defined strategy helps the trader to trade more comfortably and confidently. Lack of it could result to disaster of having the entire capital wiped out.

Take Profit

A take profit on the other hand defines the amount of profit a trader is willing to take. Having a set take profit level helps traders manage the level of greed.

Based on the trading strategy. Take profit levels are always higher than the stop loss levels. This way, the trader has higher chances achieving long-term profitability.

A case scenario is having a risk reward ration of 1:3. This means for every coin of stop loss, there is a take profit of three coins. Stop loss and take profit levels are unique and determined by the trader’s strategy. Hence, the ratios are not universal.

These are some of the most common words used in Forex trading. It all starts with theoretical understanding before putting them into practical use.

It is key to note that Forex trading is a risky venture and majority of traders lose their money. Hence, it is advisable that you only invest in the funds you are willing to lose.

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