Just getting started in FX? Feeling a little rusty? Need a refresher? Whatever you’re after, it’ll help you to have a read through our glossary of a dozen trading terms you’re bound to come across in Forex.
1. Base Currency & Counter Currency
The base currency is the first currency quoted in the pair, while the counter currency is the second. So taking the example of the EUR/USD or EURUSD, here the Euro is the base currency and the US Dollar is the counter currency.
2. Long And Short Positions
Because currencies are priced as pairs, when you enter a trade you will always be long and short a currency at the same time. Convention dictates though that a long EURUSD position would mean that you are long (buying) the base currency and short (selling the counter currency). So long EURUSD means buying Euros and selling US Dollars. Short EURUSD would be selling Euros and buying US Dollars.
Currency pairs are traded in lots; however, the type of account that you open with the brokerage determines the type of lots used. There are standards lots, mini lots and micro lots, which correspond to 100000 units, 10000 units and 1000 units of base currency per lot. Typically retail trading accounts use mini lots which are 10000 units of base currency. If you buy a mini lot of EURUSD at 1.3200, you are buying 10000 Euros (the base currency) and selling the equivalent amount of Dollars (the counter currency) determined by the exchange rate of 1.3200. So you would have sold 10000*1.3200 = 13200 dollars.
Most currency pairs are quoted to five decimal places of accuracy, although this is quite a recent change. Previously there was a system in place of four decimal places of accuracy and the term pip was derived from the smallest change in price using the old four decimal place system as a pip actually stands for a Percentage in Point or 1% of 1%. As such, a change in price for EURUSD from 1.32000 to 1.32010 is a change of one pip. Yen pairs however are quoted as three decimal places of accuracy because the price range for Yen pairs is typically a hundred or so times higher, meaning that a change in USDJPY from 99.000 to 99.010 is a change in price of one pip.
5. Stop Loss
This is a method of registering with the broker, the price at which you want to close the trade for a loss. It is important to use stop losses when learning to trade because there is a high probability that you will be wrong a lot of the time. Even experienced traders don’t have 100% success rates. Typically pro traders get it right between roughly 50% and 85% of the time depending on their trading style, so the ability to exit a losing position is crucial for preservation of capital.
6. Take Profit
Similar to a stop loss, this is an order that can be placed at the broker that will close your trade at a predefined price in order to lock in profit.
7. Buy Limit/Sell Limit
Buy Limit is an order than can be placed at the broker to enter long when price drops down to a specified level from the existing price, while conversely, Sell Limit is an order than can be placed at the broker to enter short when price rallies up to a specified level from the current price.
8. Buy Stop/Sell Stop
A Buy Stop is an order than can be placed at the broker to enter long when price rallies up to a specified level from the current price, while a Sell Stop is an order than can be placed at the broker to enter short when price drops down to a specified level from the current price.
9. Market Entry
Market entry is an order that enters at the current price, regardless of what that price is. These can be long or short.
10. Spread, Commission And Slippage
This is the difference in price between the nearest buy orders and the nearest sell orders within the interbank market. Brokers also typically make spreads a little wider than the spreads that they receive from their liquidity providers in order to make a small profit from each trade placed. The exception to the rule is when a broker charges a commission for each trade which then allows the broker to offer very low spreads because their revenue is made from the commissions. During times of high volatility, such as major news events, the spread can widen unless your broker has a fixed spread policy. This can work to your advantage and to your disadvantage, as your order may be filled at a better or worse price that assumed.
Brokers are the interface between you as the trader and the market. There are many different types of brokers and their descriptions would take up far too much space in this section to go into detail; however it is worth understanding the differences if you are new to trading. One popular type of broker is the ECN broker. These brokers take all of the long and short orders from all of their clients for each price (there will typically always be long and short orders at every price). Any longs at the same price as shorts at the brokerage are able to simply trade with each other internally between clients at the brokerage, without even being exposed to the outside market. Whatever exposure is left from all the longs and shorts added together at each price will be traded in the market via the brokers’ liquidity providers (typically a selection of banks or other ECN networks).
Volatility is simply the amount of price movement over a specified time. It is typically measured as a percentage price movement per day, although it is often important to be aware of intraday volatility. Before a major news release or Central Bank meeting, volatility will drop significantly because traders will be unwilling to enter new positions until the outcome of the risk event is known. Likewise, when an important piece of market-moving news occurs, volatility will increase.