Forex Terms and Concepts
Like in any work environment, getting a hold of the terminology used on a daily basis is crucial. Trading forex is no exception. In this article we will go through some of the terms that we think are most commonly used in Forex. These are essential to better understanding how the market works.
All transactions being made in foreign exchange involve buying a currency while selling another one. Furthermore, a currency’s value can only be determined through comparison with another one. As such currencies are quoted in pairs. For example, one of the most traded currency pairs is the EUR/USD.
In this case, the base currency, the one on the left of the slash is the Euro. Conversely, the US Dollar is designated the quote currency. The base currency is the security you want to buy or sell while the quote currency sets the price at which you can exchange the base currency.
Still on the EUR/USD example, if the quote is 1.1862, this means that to buy 1 euro you would have to sell 1.1862 dollars. If the trader wanted to sell 1 euro he would receive 1.1862 dollars.
These currency pairs can be thought as being a single asset being traded. So, if someone buys the EUR/USD pair, this means that they are exchanging dollars for euros and when selling the other way around.
Major and Minor pairs
When talking about currency pairs, they can be usually referred to as Major or minor pairs. Major pairs are among the most transacted in Forex and the ones that offer more liquidity. For example the EUR/USD, USD/JPY and GBP/USD. All other currency pairs that aren’t as transacted are considered to be minor pairs.
It is also important to point out cross currency pairs. Although not so commonly traded, these are the currency pairs that don’t involve the USD, and thus usually have associated with them higher transaction costs.
Pips and Pippetes
A pip (percentage in point) is the most basic measurement of price movement in currency pairs in the Forex market. Usually, currency pairs are expressed to the fourth decimal case, being the pip the last one. For added precision, some traders even look at pippete, which are 1/10 f the pip, in other words, the fifth decimal case. So, for instance, if a currency pair changed from 1.1862 to 1.1863 this meant that it changed 1 pip. This measurement applies to most cases but there are some exceptions, such as the USD/JPY (109.55) which is presented in most cases to the second decimal case.
Being aware of pip variation is extremely important when calculating expected returns and positioning yourself in the market.
The bid is the price that traders are willing to pay to acquire a security. On the other hand, the ask is the price that traders are willing to make to sell a security, being the bid the smallest of the two. These are, essentially, indicators of the supply and demand for a specific security. The difference between both gives us the bid ask-spread. The tighter the gap between both the more liquid is security being traded. In other words, it can be sold more easily and quickly converted to money. Trading currency pairs are thus considered to be the most liquid assets to trade.
You can think of this as an ongoing negotiation taking place in the market. On one side you have those who want to exchange the base currency for the quote currency. On the other side, you have those that want the exact opposite. The broker/market maker will offset this apparent imbalance in the market and charge you the spread every time you want to exchange. This is considered the main transaction cost each time you trade.
It is important to point out that the current price of a pair is usually neither the bid nor the ask. It is the price at which the currency was last exchanged.
As previously mentioned, when buying/selling currency pairs, this is usually done depending on a traders’ belief on the future value of the base currency compared to the quote currency.
A trader is said to be bullish when he has a positive expectation regarding the value of a pair. In foreign exchange, like in any other market, bull traders hope to profit from an upward movement in a pairs’ price. Simply put they hope to buy and hold a currency pair and eventually sell it at a higher price after appreciating in value. This is usually designated as “opening a long position“.
Investors’ and traders’ attitude towards the market is called sentiment. So, even though there are bull traders, pessimistic traders also exist.
Which brings us to bearish traders. A trader is said to be bearish when he expects a currency pair to devaluate. In this case, they will go short on a currency pair. This means that a trader will borrow a currency pair from a broker, sell it and then, when closing the short position, repurchase it to the broker at a lower price.
To Sum Up
There a lot of jargons used in Forex and it can be easy to be overwhelmed with all of these concepts. However, when you get down to what they really mean, it isn’t all that difficult.
Constantly learning about new ones, or just reviewing them, is essential to becoming a better trader. With this in mind, we advise you to read more on our other articles and improve your knowledge on the subject.
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