The currency trading market has its own unique set of jargon and terms. You need to know some of the basic forex terminology you may encounter whilst trading.
Basic Currency Trading Terms
This is used to express the value of one currency to the value of another. An example is GBP/USD is 1.5100; one pound would be worth US$1.5100.
This is the smallest price movement of a currency. It is also referred to as a point. For example, one pip for the USDJPY is equal to 0.01.
This is the amount required to open a position or maintain it. Margin may be used or free. Used margin is the amount that you require to maintain a position that is open. Free margin is the amount that you have available for new positions. If you have a margin balance of $1,000 in your trading account and you carry a 1% requirement for margin to open a new position, you can potentially purchase or dispose of a position up to an amount of $100,000. This is if you use leverage of 100:1.
If your account falls below the minimum required to maintain your open position, you will be sent a margin call which requires you to add more funds to your account or to close that position. Most currency trading brokers opt to automatically close your position if your margin falls below the required amount. The amount you require to maintain a position that you have opened depends upon your broker. It is sometimes 50% of the original amount which was required to open the position.
Leverage is used to increase your account to a value greater than your total margin. An example is where a trader has $1,000 in his account and he opens a position worth $100,000. In this case he leverages his total account by a ratio of 100:1. Likewise, if he uses a ratio of 200:1, he would be opening a position with margin of $1,000 in his trading account. The increase of your leverage level increases the potential of gains and losses.
The spread is the variance between the disposal quote and the purchase quote. This is also known as the bid and offer quotes. An example to illustrate this is if EUR/USD is quoted as 1.2500/04, the spread is the variance between 1.2500 and 1.2504 which is equal to four pips. For you to break even on your trade, your position has to move in the trade’s direction by an amount equivalent to the spread quoted.
This refers to the rate between two currencies where both currencies are not the domestic currency of the country where the quote is given. This is also sometimes used to refer to currency pairs where the US dollar is not one of the currencies, irrespective of the country the quote is given in.
An example to illustrate is if a rate between the Japanese yen and the Australian dollar was quoted in a Swiss newspaper, it would be considered to be a cross rate as neither the yen nor the Aussie dollar is the domestic currency of Switzerland. If the rate between the Swiss franc and the Aussie dollar was quoted, it would not be a cross rate because it includes the official currency of Switzerland.