The Most Important Forex Terms You Must Know!

Forex Trading stands for foreign exchange trading, which is the purchasing or selling of one type of currency in exchange for another. In this global over-the-counter market, investors use their Forex terms.

In this post, we explain the most important Forex terms. You will encounter these on the way to becoming a successful forex trader.

Important Forex Terms and Trades

A position, in Forex terms, describes trade in progress. A long position, for instance, means that a forex trader purchased currency expecting its value to go up.

Once they sell it back to the market at a higher price, the trade is complete, and his/her long position closes.

On the other hand, a short position refers to a situation where a trader sells a particular currency to expect its value to decrease, to buy it back at a lower price. The short position will close once the trader buys back the currency, ideally at a lower price.

If the currency pair of EUR/USD, which refers to Euro/US Dollar, were trading at1.0914/1.0916, for example, investors planning to open a long position on the Euro would purchase one Euro for 1.0916 US dollars. They will then hold on to the currency, hoping its value will increase, and then sell it back to the market once it appreciates.

On the other hand, investors looking to open a short position on the Euro will sell one Euro for 1.0914 US dollars, expecting its value to depreciate. If their expectations come true, they will buy it back at a lower rate and make a profit.

Forex Markets

With central banks, retail forex brokers, commercial corporations, commercial banks, hedge funds, individual investors, and investment management firms participating in the forex market, it is easy to see why this market is more significant than equity and futures markets combined.

Placing a trade in the forex market is quite simple. The basics of Forex Trading are very similar to the mechanics of other financial markets, such as the stock market.

Therefore, traders with prior experience in any financial market should quickly understand Forex Trading.

Pips

The Forex term pip is used in Forex to describe the change in value between two currencies as they move either up or down.

Every currency has its value, and so to calculate the equivalent value of a pip, there is a set process to follow:0001 divided by the exchange rate = Pip value There are some exceptions in the valuing of pips, particularly in the case of currency pairs that include the Japanese Yen as these are often only quoted to two decimal places.

Brokers will calculate the pip value on your behalf, but it is helpful to understand the underlying process. Ultimately, this accumulation of pips will influence the calculation of trading profit or loss.

Leverage

Leverage is the double-edged sword of Forex trading. While on the one hand, it provides retail traders with the chance to make substantial profits from the currency markets, by exploiting only relatively small movements in currency prices, it can equally lead to situations where losses, if unchecked, can far exceed original investments.

Knowing the implications of leverage, how it works, and how it can be used effectively will, over time, prove to be highly beneficial. This means learning to manage leverage to give the best possible chance of making profits while reducing the risks and possibilities of accumulating losses.

Leverage, by definition, is the instrument that allows a trader to borrow and control much more significant amounts of collateral, using only relatively small personal investment. Traders can enter transactions using this private investment, that when leveraged, is multiplied to give control of a much more significant stake of currency. This means that profits can be made from relatively small currency price movements.

The important lesson to remember is that leverage works in both directions; therefore, in the same way, that leverage will increase the value of any profits; it can also rapidly multiply any losses.

In practice, leverage will be used every time you execute a transaction order. When entering an order, you will be required to select the level of leverage you wish to apply to that transaction, determining the amount of currency you ultimately control. The margin is the amount of money you must put towards the transaction. This amount will have to be available within your account before a broker executes the trade on your behalf.

An example of leverage in action: Imagine that you have $1,000 that you wish to invest in a particular currency pair, and you decide to enter a buy transaction, also known as going long. The broker will give you various leverage options as you place your order, depending on your account type. For this example, we can use a leverage level of 100:1. This means that your investment of $1,000 is multiplied by 100, giving you control of $100,000 of currency. It is that level of currency that is then applied to the trade, and you enter the market theoretically holding that amount to invest. Suppose you have judged correctly when you close the trade, and the currency’s price has increased. In that case, that price rise is applied to the $100,000 rather than your margin amount of $1,000, thus considerably increasing the level of profit accumulated.
Conversely, if you have misjudged the market and the price closes lower throughout the trade, the same leverage is similarly applied to any losses. This would mean that you lose your margin investment and accumulated losses over and above the margin level. Stop orders can be used to reduce your losses should the market move against you. This type of order will be discussed in more detail in later sections.

Key Lesson: A statement that you will regularly encounter throughout your trading experiences will be the following warning:

This is a leveraged product and can result in losses that exceed your initial deposit. Trading Forex may not suit everyone, so please ensure that you fully understand the risks involved.

Forget this at your peril! Keeping this assertion at the forefront of your mind and applying caution every time you trade reduces the risk of financial losses.

Lots

Another famous Forex term is “Lots”. The Spot Forex market is traded in Lots regarding actual trade orders. Lots come in various sizes, including Standard, Mini, Micro, and Nano, each made up of different amounts of currency units.

Lots of work using the principles of leverage that we have already discussed. They structure the specific amounts that can be applied to each trade. Each lot is constructed from currency units, which translates into real-term values. Therefore a standard lot consisting of 100,000 units can be equivalent to a controlling monetary value of $100,000, etc.

Margin

As previously mentioned in connection with leverage, it is not necessary to have an account funded with $100,000 to control a lot of currency with that equivalent value. Instead, following the application of leverage, a broker requires you to have a percentage or deposit on account, to which this leverage will be applied when you trade. This percentage or deposit is what is known as the Account Margin. The value of this deposit will depend on the type of account held, the specific requirements of your broker, and your individual preference.

Brokers will often require the account to be sufficiently funded above the account margin so that any surplus amount can be available to fund possible losses.

Forex Terms: Bids, Offers, and Spreads

When dealing with the pricing of currency in the Spot Forex market, there will always be two prices at any one time for every currency pair. These two prices are known as the bid and offer price, and the difference between them is known as the spread. Understanding the difference between these two values is essential, as they are a vital element of all trading strategies.

Key Lesson: The bid price will be the price quoted at which you can sell currency, and the offer/ask is the price you will be quoted when you wish to purchase currency.

The bid price will always be lower than the offer/ask price, and it is this spread between the two prices that allows brokers and market makers to profit from transactions.

Long and Short Positions

One of the most attractive features of the Forex market is the opportunity to make profits whether prices go up or down. As a trader, it is possible to accumulate pips irrespective of whether they come from upward or downward trends, significantly increasing the potential returns available and providing considerable flexibility for developing a trading strategy.

When a trade is made, the Forex term used to describe this is taking a position. If the trade is based on a transaction where the trader predicts that the price of a currency will increase over the duration, then this is known as a long position or going long. Conversely, when the trader makes a transaction that predicts that the price will decrease throughout the trade, this is known as a short position or going short.

Order Types

To execute either the purchase or sale of currency, it is necessary to provide instructions on the quantity and method with which a trade should be conducted. The combination of these instructions is known as an order. There are four main types of order, and it is vital to be aware of the nature and implications of each.

Market Order

The market order, sometimes known as a free order, is an instruction to buy or sell at the best available current price. This means that a trade will be executed immediately at either the current ask price or bid price depending on whether the trade is for a purchase or a sale. Therefore, if the bid price for GBP/USD is 1.5673 and the asking price is 1.5675, then, with a market order, you would buy at 1.5675 and sell at 1.5673.

Limit-Entry Order

The limit-entry order is an instruction to buy at a certain level below the current market price or sell at a certain level above the current market price. Depending on the direction of the particular order, then limit orders can be further specified as either a buy limit order or a sell limit order.

This type of order can be used to ensure that you don’t miss the opportunity to make a trade. They are also handy for executing a specific trading strategy, as they ensure that entry and profit targets can be set and executed accordingly.

Limit orders generally cost more to use than market orders. However, the benefits to the trader often outweigh the extra cost.

Stop Order

The stop order is an instruction to buy or sell when the price reaches a predetermined level. This means that it can be used to set entry and exit targets to limit potential losses or lock-in profitable gains. The stop order is often referred to as either a stop or a stop loss. The specific methods for using this type of order will be discussed later.

Stop orders are not always guaranteed to get specific entry or exit points. When there are sudden swings in price, your broker may only be able to practically execute the stop order at levels lower or higher than initially expected.

It is essential to read and understand the specific guidelines for your broker's execution of stop orders, ultimately influencing how you utilize them in your trading strategy.

Other Order Types

In addition to the four main order types, several more unusual order categories are more suited to experienced traders. You never have to use these order types, but it can be helpful to be aware of them. They include Good-Until Cancelled (GTC), Good-for-the-Day (GTD), One-Cancels-the-Other (OCO), One-Triggers-the-Other (OTO).

Key Lesson: In practice, the stop order can help ensure that profits are collected before trend reversals or as an essential tool to limit the potential risk associated with each trade. Setting a stop loss below an entry point when going long on trade will help ensure that if the price reverses, losses are kept to the absolute minimum. The opposite should be applied in a short trading scenario.

Forex Term: Trading Strategy

The exact locations for the placement of stop orders will depend upon the trading strategy employed. However, it is worth being aware that if the stop order is set too close to an entry-level, then small oscillations in price may lead to a trade being closed prematurely. Therefore, it is sensible to place stop orders below or above significant support or resistance levels.

Trailing Stop

The trailing stop is a Forex term that describes a specific stop order that moves about price fluctuations.

A trailing stop adjusts according to the direction of a particular trade, tracking the price of a currency. The result produces a stop level that is constantly changing about price movements so that the point at which a trade could close is adjusted. This helps to lock in profits and automatically reduce any losses if the price reverses.

Key Lesson: The trailing stop order is essential for Forex traders and should be integral in many trading strategies. Trading Strategy: If you decide to go long on the GBP/USD and buy for 1.5780, you could set a trailing stop at 20 pips (initially 1.5760). This will mean that, should the price move against you and drop through the 1.5760 value, your stop would be activated, and the trade closed. However, should the price increase, as you predicted, the trailing stop should track this value and increase correspondingly. Should the price continue to reach 1.5800, then the trailing stop would now be set at 20 pips below this new level, i.e., at 1.5780. The stop level will continue to rise proportionally to correspond with any price rises. Should the currency price fall, then the trailing stop does not drop back but remains at whatever level is reached before the reversal, in this case, 1.5780. The trade will remain open if the market does not move against you by more than 20 pips; the trade would be closed. The overall result is that most gains accumulated during the work are locked in.

Placing an Order

The exact procedure to follow when placing an order will vary slightly between brokers and different trading platforms. However, irrespective of the precise method, whenever you place an order, you will need to consider several common factors that will form the basis of your trading strategy: – Select which currency pair you wish to trade.

  • Decide whether you are going long or short on the trade.
  • Check your analysis and ensure that you know where the price could be going.
  • Check indicators and tools to reinforce the strategy.
  • Predetermine exit points (using support and resistance).
  • Predetermine a profit target (don’t get greedy!).
  • Select an order type.
  • Select the lot size.
  • Manage the risk associated with the trade (this will be discussed in more detail in later sections).

This, or a similar checklist, should always be used before you make any transactions. Going through each stage methodically will help structure how you execute transactions and help prevent making mistakes. It serves as a check and balance system that will help analyze each trade from several perspectives before making any commitments.

Once an order has been executed, it is essential to monitor the trade and implement tools that will help analyze the overall performance. Effective Forex trading requires keeping a cool head to try and not act too impulsively.

Key Lesson: It is essential to stick to a strategy. There will often be situations where you may hit your profit target and feel that you have further potential to make money by staying in the trade. Chasing profits can be dangerous, and remaining in a trade longer than planned can increase the possibility of being hit by price reversals. These risks can be reduced by closely monitoring trades and setting stop losses at appropriate levels.

Similar situations can occur in loss-making trades where it can be tempting to stick with a trade hoping that it will ultimately reverse. Set a stop loss and stick with it. Losses are a fact of life for regular Forex traders but ensuring that they are kept to an absolute minimum will ensure that you win more times than you lose.

That was an overview of the most popular Forex terms. Of course there are many more! Which one do you remember? Write us a comment!

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