The best way to get started on the forex journey is to learn its language. Here are a few terms to get you started:
- Forex account: A forex account is used to make currency trades. Depending on the lot size, there can be three types of forex accounts:
- Micro forex accounts: Accounts that allow you to trade up to $1,000 worth of currencies in one lot.
- Mini forex accounts: Accounts that allow you to trade up to $10,000 worth of currencies in one lot.
- Standard forex accounts: Accounts that allow you to trade up to $100,000 worth of currencies in one lot.
- Ask: An ask (or offer) is the lowest price at which you are willing to buy a currency. For example, if you place an ask price of $1.3891 for GBP, then the figure mentioned is the lowest that you are willing to pay for a pound in USD. The ask price is generally greater than the bid price.
- Bid: A bid is the price at which you are willing to sell a currency. A market maker in a given currency is responsible for continuously putting out bids in response to buyer queries. While they are generally lower than ask prices, in instances when demand is great, bid prices can be higher than ask prices.
- Bear market: A bear market is one in which prices decline among currencies. Bear markets signify a market downtrend and are the result of depressing economic fundamentals or catastrophic events, such as a financial crisis or a natural disaster.
- Bull market: A bull market is one in which prices increase for all currencies. Bull markets signify a market uptrend and are the result of optimistic news about the global economy.
- Contract for difference: A contract for difference (CFD) is a derivative that enables traders to speculate on price movements for currencies without actually owning the underlying asset. A trader betting that the price of a currency pair will increase will buy CFDs for that pair, while those who believe its price will decline will sell CFDs relating to that currency pair. The use of leverage in forex trading means that a CFD trade gone awry can lead to heavy losses.
- Leverage: Leverage is the use of borrowed capital to multiply returns. The forex market is characterized by high leverages, and traders often use these leverages to boost their positions.
- Example: A trader might put up just $1,000 of their own capital and borrow $9,000 from their broker to bet against the EUR in a trade against the JPY. Since they have used very little of their own capital, the trader stands to make significant profits if the trade goes in the correct direction. The flipside to a high-leverage environment is that downside risks are enhanced and can result in significant losses. In the example above, the trader’s losses will multiply if the trade goes in the opposite direction.
- Lot size: Currencies are traded in standard sizes known as lots. There are four common lot sizes: standard, mini, micro, and nano. Standard lot sizes consist of 100,000 units of the currency. Mini lot sizes consist of 10,000 units, and micro lot sizes consist of 1,000 units of the currency. Some brokers also offer nano lot sizes of currencies, worth 100 units of the currency, to traders. The choice of a lot size has a significant effect on the overall trade’s profits or losses. The bigger the lot size, the higher the profits (or losses), and vice versa.
- Margin: Margin is the money set aside in an account for a currency trade. Margin money helps assure the broker that the trader will remain solvent and be able to meet monetary obligations, even if the trade does not go their way. The amount of margin depends on the trader and customer balance over a period of time. Margin is used in tandem with leverage (defined above) for trades in forex markets.
- Pip: A pip is a “percentage in point” or “price interest point.” It is the minimum price move, equal to four decimal points, made in currency markets. One pip is equal to 0.0001. One hundred pips are equal to 1 cent, and 10,000 pips are equal to $1. The pip value can change depending on the standard lot size offered by a broker. In a standard lot of $100,000, each pip will have a value of $10. Because currency markets use significant leverage for trades, small price moves—defined in pips—can have an outsized effect on the trade.
- Spread: A spread is the difference between the bid (sell) price and ask (buy) price for a currency. Forex traders do not charge commissions; they make money through spreads. The size of the spread is influenced by many factors. Some of them are the size of your trade, demand for the currency, and its volatility.
- Sniping and hunting: Sniping and hunting is purchase and sale of currencies near predetermined points to maximize profits. Brokers indulge in this practice, and the only way to catch them is to network with fellow traders and observe for patterns of such activity.