Forex Terminology
Forex markets have their terminologies. The Forex market has many terms which is being shared with other financial markets but which mean different things in the Forex market. There are some words which are unique to Forex. In this article, we will have a closer view of the Forex terms. These terms will be used mainly in other articles in this module.
Base and Counter Currencies
In stock and bond markets one can sell their security. This implies that they can transform their security into money. But, in the Forex market, one is already buying and selling currencies. So how does the trading work?
In the Forex markets, currencies are bought and sold simultaneously. This implies that one exchanges one form of currency for another. Hence, the currencies prices are always quoted in pairs. The price indicates the unit of the first currency that one is willing to pay for the second currency. The second currency quoted in the pair is the counter currency.
For instance in USD/EUR pair, the US dollar is referred to as the base currency while the Euro is called the counter currency.
Long and Short Positions
Similar with the stock and bond markets, in Forex markets traders are allowed to take long and short positions. However, the meaning of long and short positions varies in this market. This is due to currencies are traded in pairs. Hence, new investors get confused with what happens when they go long and what it means to go short.
In the Forex market going long means you are buying units of the base currency and selling units of the counter currency. When one already has a long position and persist with going long, they are said to be going longer!
For instance, if you want to go long on the USD/EUR pair, you have to buy the USD and sell EUR in the market.
Furthermore, in the Forex market going short means you selling units of the base currency while buying units of the counter currency. Adding to the short position is indicated as going shorter. Therefore if you are to go short on USD/EUR pair, you have to sell USD while buying the EUR simultaneously.
Also, returning to a zero position from a long or short position is referred to as squaring off. If you wish to go long, you have to sell to square off whereas if you wish to go short, you have to buy to square off.
Bid, Ask and Spread
Market markers run the Forex markets. They supply a two way market for all currencies at all times. Hence, they provide buy and sell quotes. Their buying price is always less than their selling price. The different is meant to reward them for the risk they are taking by holding a volatile asset for an ambiguous period.
The price at which they are ready to buy is called the bid-price while the price at which they are prepared to sell is called the ask-price. The difference amid the two is called the bid-ask spread, also known as the “spread.”
Lots
This term is usually used when the Forex market derivatives are being traded. The Forex market future contracts always have a fixed size. For example, US dollar contracts may be available in numerous of $5000. Hence, every $5000 contract is referred to like a lot. However, if you wish to buy $25,000 in the future, you will have to buy 5 lots. Market makers provide more flexibility to currencies with higher liquidity, because each currency has different slot sizes.
Pip
This is the minimum amount at which the currency quote can move. The regular pip refers tp1/10000 of the quoted currency. This implies that a currency must change by at least 0.00001%for there to be an effect on the quoted prices in the markets.
Pips have become a part of the Forex trader language. Changes in profits made and prices are expressed regarding pips. However, since the pip can be referred to as the variable amount of money, it requires some experience to understand what is being exchanged.
Value Dates and Rollovers
Value date is the date at which the teams to the trade agree to settle their accounts. This implies that the open positions of all derivatives contracts are automatically closed on the values date. Hence, contracts are more volatile when they are closer to the value date.
Also, in some situations, traders decided to roll over their contracts. This implies that they choose to settle their contracts n the next value date rather than the current value date. To do so, both parties must agree, and also there have to be fees paid based on the interest rate differences between both currencies.
Several terms are frequently used in the Forex market. However, those terms may be referred to strategies used in the market and are therefore beyond the scope of this basic article. In general, Forex trading has its terminologies which one must get used to.