The foreign exchange market sees over $5trillion dollars traded within it every day. Trading by individuals in this market is also growing in popularity, and we are seeing more and more people getting involved and starting to look at how they might trade.
Before starting to trade, it is important to start with the basics and understand the terminology that traders use and what they mean. To help, we have pulled together some of the most important ones to grasp and understand.
Exchange rate: This is simply the value of one currency expressed against the other. For example, if EUR/USD is 1.3200, this means that one Euro is worth US$1.3200.
Pip: A pip is the smallest increment of price movement a currency can make. It is essentially a measurement of a very small percentage change. A pip is always a standardised size and represents the smallest amount that a currency can change.
Leverage: This is the ratio of the transactions size compared to the actual investment used for margin. Using leverage allows a client to trade without putting up the full amount. For example, if a trader has £1,000 of equity in an account, you can have leverage of £100,000. In this instance they will have leveraged their account by 100 times, or 100:1.
Margin: This is the deposit required to open or maintain a position. A margin can either be called free or used. A used margin is that amount in use to maintain an open position, whereas a free margin is the amount available to open new positions. Most brokers will automatically close a trade where a margin balance falls below the amount required to keep it open, this is called a ‘margin call’. The amount required to maintain an open position is dependent on the broker and can be 50% of the original margin required to open the trade.
Spread: The spread is the difference between the market price, buy price and sell price. To break even on a trade, your position must move in the direction of the trade by an amount equal to the spread. When trading forex, the spread will be determined by the wider market.
Bid price: The bid is the price at which the market (or your broker) will buy a specific currency pair from you. This means that at the bid price, a trader will sell the base currency to their broker.
Ask price: This is the price at which the market (or your broker) will sell a specific currency pair to you. This is the price you can buy the base currency from your broker.
These are some of the fundamental and basic terms everyone needs to know before you start your trading journey.
Above all else, it is also worth remembering that when trading, your capital is at risk. You can get help on reading the market, opportunities and risks from Learn to Trade.
The information here has been prepared by Learn to Trade. It is offered as an opinion and should not be considered an offer or solicitation to invest. Whilst the information provided is believed to be accurate at the time of publication, no guarantee is offered on the accuracy or completeness of the information given. Learn to Trade accepts no responsibility for the information and comments. Consequently any person acting on it does so entirely at their own risk.
Ben Sparham, Senior Trader Mentor at Learn to Trade