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Basic Forex terminology: lot, leverage, stop loss
Orientation in a new environment is not easy. Perhaps all professions have a minimum terminology outsider won’t understand. Forex is no exception. Let’s take a look at some basic jargon and explain a few terms in our business.
What is “a lot”
A lot is a basic buying or selling investment volume. One lot represents 100 000 units of basic currency, typically US dollar. In the olden days, lots were the only unit to trade with. This was a drastic limitation to small traders. Today, it’s a mere term as you can trade in smaller volumes (micro-lots and nano-lots) or use leverage.
For example, one nanolot equals 100 units. If you don’t use leverage, the number of lots is the only variable you can choose to change the size of investment.
If you open a position equal 1 lot for the currency pair EUR/USD each pip will represent a difference of USD 9.99734. This means that a price movement by 10 pips in your favour will earn you approximately USD 100.
What is margin and leverage
A lot is closely related to two further terms: margin and leverage. Most of you have already heard of leverage trades. If the broker offers you a leverage of 1:100 this means that with USD 1 000 you will be allowed to control up to USD 100 000. One lot will cost you USD 1 000 instead of USD 100 000.
What are these things good for? Of course, for increasing your profit.
If you sell e.g. EUR/CZK without using a leverage and the size of your position is 1 micro-lot (1000 units) and Czech Koruna devaluates by one CZK, you will earn CZK 1 000. Using a leverage of 1:100 the same money will generate you 1 lot – so you have earned hundred times your investment, that is CZK 100 000, which is tempting.
Remember that this rule also works in the opposite direction. If your position includes 1 lot (EUR 100 000) and CZK gets stronger by one CZK you will lose CZK 100 000.
Some brokers allow trading with a 1:1 or 1:400 leverage. But as far as I know, CySEC recently ordered a maximum leverage of 1:10 for all licensed brokers. The more one should be cautious about which broker to chose for trading.
Because leverage trading is used often, the broker will, with each trade, block part of your account called margin. This will protect the broker from a potential loss. As long as the broker feels that the trade is in jeopardy, tehy may make a margin call = to ask you to add cash to your trading account. If you don’t do it or your loss is too high, the trade will close automatically. In fact, this is a good precaution. You may lose the margin and trading account, but at least you are not in debt.
This is also a means of protection for the opposite party. The foreign exchange market is built on the demand and supply principle (by which one side is selling while the opposite one is buying). If you don’t set your stop loss right and your trading account enables falling into red numbers it is likely that after a poor trade you will end up as a debtor! This is a disadvantage of Forex trading against binary options. We have talked about it in the previous article. With binary options, this can never happen.
What is stop loss and take profit?
You must have read, that when trading on Forex markets, losses and profits are unlimited, which is frequently stressed at our website. It is more or less true, which is why every serious trader in this business uses stop loss and take profit. These are price limits at which a trade will close automatically either in profit (take profit) or in loss (stop loss).
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Traders enter the stop loss and take profit orders usually when opening a trade or soon afterwards. The limits should be derived from the trading plan. Once entering the market, you immediately know what you may expect: what profit you might achieve or what loss you are will be able to tolerate. This type of information is available. So why shouldn’t you use it! Once entered, the stop loss and take profit will display on the broker’s screen. Even if you switch off your PC, these levels will remain active. So, you don’t have to fear of your money.
There are loads of terms used by traders in the Forex market. For instance, pip which is the minimum price movement of a given instrument (currency). A lot of these terms are in English. I am sure that you will easily absorb more of the trader’s jargon. However, if you have some questions do not hesitate to ask us in the comments section below.
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I’ve wanted to build a business of some kind and earn money since I was in middle school. I wasn’t very successful though until my senior year in highschool, when I finally started to think about doing online business. Nowadays I profitably trade binary options full-time and thus gladly share my experiences with you. More posts by this author
8 Basic Must Know Forex Trading Terms
The Forex market is a crazy place, full of terms that a lot of people have never heard before. While having some previous experience trading stocks or futures is helpful to a budding Forex trader, there are a few terms that can be misleading to someone with no prior experience.
The following is a short list of some extremely basic terms that no one trading Forex can stand to be ignorant of.
The Forex or foreign exchange market is a group of traders conducting tens of trillions of dollars worth of trades 24 hours a day, six days a week. When the Forex or FX market is in session, individuals, governments and major banks all over the world trade currency pairs with one another constantly. Mere seconds can mean the difference between making and losing money, and those same seconds can equal the difference between small and large changes in one’s wealth.
Currency pairs are when two types of money are traded for one another. One can trade nearly any kind of currency against nearly any other kind, provided someone in the Forex market has it available. For example, one can trade US dollars versus Japanese yen, or Euros versus Great British pounds. Since there is no unilateral standard for what a particular currency is worth, the market is in constant flux as currencies move upward and downward against one another.
In most cases, there are seven major currencies being traded. These currencies include the ones mentioned above, as well as Australian and Canadian dollars and Mexican pesos. However, since there are over a dozen different currencies available in the Forex market, there are dozens of different currency pairs one can trade.
The spread is the difference between the bid or buying price for a currency and the ask or selling price for it. An individual trading currencies has to use a broker, and every broker attaches a spread to the currency they trade, which is where they make their profit.
When you trade currencies, you watch the numbers in your currency pair. If the currency you hold has a higher number than that of the currency you are about to trade for, you will make a profit. If the reverse is the case, you will take a loss. Naturally, making a profit is in your best interests.
A pip is the smallest unit on the Forex market. In some cases, two currencies have four digits to the right of the decimal point–the furthest right is the pip. In others, most notably those involving Japanese yen, the pip is the second number from the decimal point. One pip of difference between two currencies may represent only a tiny amount of money going into your retirement fund, but there is an ace in the hole: leverage.
Unless you are watching Mr. Wizard, leverage refers to the use of credit or margins to trade currencies on the Forex market. With leverage, an individual can make one dollar have as much power as fifty dollars. This leverage must be used carefully because it can lead to heavy losses, which we will discuss in the next section.
Margins are more than just the edges of a piece of paper. Margins are also the credit many brokers will extend to traders, which allow them to trade large amounts of money without investing nearly as much. One can use $10,000 to wield half a million dollars, simply through the use of margins. However, there is a risk which comes with this power.
Sometimes, the Forex market becomes as scared a place as any other market. Rather like during the Panic of 2008 in the stock market, trading comes to a near standstill and many large players lose confidence. This tends to initiate a margin call, which is when everyone who is trading on margins has to return all of the money they borrowed. This can be problematic if one owns currencies which have changed value against them.
During a margin call, a trader is responsible for all of the money they have borrowed, which can subject them to losses far beyond the money they originally invested. Thus, it is extremely important to initiate a stop loss.
A stop loss is your best friend. Provided you set a stop loss properly, or set a trailing stop loss, you will only stand to lose a small amount of your investment, regardless of where the Forex market goes. A regular stop loss will stay at a particular valuation between currencies permanently, while a trailing stop loss will continue with your position no matter how high it may go. Once you have a decent profit, a trailing stop loss will protect your profit.
Long Versus Short
Holding a long position in a currency means keeping it for an extended period, often for at least a week. In the Forex world, a week can be a very long time. Occasionally traders will even keep positions for several months, and ride a long-duration trend in that position. However, shorting or short selling a currency is a bet against it going downward. When a trader shorts a currency, they buy a currency trading against it.
Closing it Up
The Forex market is a place where having a good command of a few basic terms is crucial to having any kind of success. Opinions vary widely on what constitutes a successful trading strategy, but without the above terms, the only terms you will get to know well are loss and tax deductions.
Yohay Elam – Founder, Writer and Editor I have been into forex trading for over 5 years, and I share the experience that I have and the knowledge that I’ve accumulated. After taking a short course about forex. Like many forex traders, I’ve earned the significant share of my knowledge the hard way. Macroeconomics, the impact of news on the ever-moving currency markets and trading psychology have always fascinated me. Before founding Forex Crunch, I’ve worked as a programmer in various hi-tech companies. I have a B. Sc. in Computer Science from Ben Gurion University. Given this background, forex software has a relatively bigger share in the posts. Yohay’s Google Profile
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IMHO, Very clear for understanding for all traders. Is there any opportunity for me to guest post on your blog too?
There are guest post opportunities. Please write to me for details.
Hi there Yohay, Maybe you could help me on my little issue with one of the leading forex/option brokers at the moment. Before you click on a quote price (whether you pick sell or buy), you see 3 prices in the platform…the quote price, the bid and the ask prices. If you either clicked sell or buy, that’s your trade which either has fallen on the bid or ask price for that particular time. At least that is my understanding before you decide to trade. If my understanding is correct, then how come my trade were automatically stopped by the system at a bid price that was for a certain quote price that took place 6 hours after my trade? Note that 1) I have set my stop at 95% +/-. 2) the quote price when it was automatically stopped by the system was 9 pips below opposite my trade 3) The system did not stop my trade when it was about 26 pips opposite my trade. 4) Where does the bid and ask prices on my trade in the equation that the broker has been insisting that the price reach my stop based on the bid price for the quote that was 6 hours after my trade. Thanks
It seems like an issue with the broker. I think you should take it to your broker and if it isn’t resolved, perhaps look for another one.
Thanks Yohay! Actually I’ve raised the issue with them and we had about 40+ email exchanges, and all they can say all the time was that the trade have correctly expired at a bid price that was for a certain quote price. thanks anyway for your feedback.
Forex Crunch is a site all about the foreign exchange market, which consists of news, opinions, daily and weekly forex analysis, technical analysis, tutorials, basics of the forex market, forex software posts, insights about the forex industry and whatever is related to Forex.
Foreign exchange (Forex) trading carries a high level of risk and may not be suitable for all investors. The risk grows as the leverage is higher. Investment objectives, risk appetite and the trader’s level of experience should be carefully weighed before entering the Forex market. There is always a possibility of losing some or all of your initial investment / deposit, so you should not invest money which you cannot afford to lose. The high risk that is involved with currency trading must be known to you. Please ask for advice from an independent financial advisor before entering this market. Any comments made on Forex Crunch or on other sites that have received permission to republish the content originating on Forex Crunch reflect the opinions of the individual authors and do not necessarily represent the opinions of any of Forex Crunch’s authorized authors. Forex Crunch has not verified the accuracy or basis-in-fact of any claim or statement made by any independent author: Omissions and errors may occur. Any news, analysis, opinion, price quote or any other information contained on Forex Crunch and permitted re-published content should be taken as general market commentary. This is by no means investment advice. Forex Crunch will not accept liability for any damage, loss, including without limitation to, any profit or loss, which may either arise directly or indirectly from use of such information.
Learning a foreign language starts with the alphabet – and so does forex.
Forex has its own language, that is, special terminology. If you don’t want to be embarrassed in front of other traders, it’s useful to know that a pip is not a seed in an orange, and execution is not about playing Russian roulette.
It is the quotation of one currency unit against another currency unit.
For example, the euro and the US dollar together make up the currency pair EUR/USD. The first currency (in our case, the euro) is the base currency, and the second (the US dollar) is the quote currency.
As you see, we use short forms for currencies: euro is EUR, US dollar is USD, and Japanese yen is JPY.
It is the rate at which you exchange one currency for another. The exchange rate shows you how much of the quote currency you need if you want to buy 1 unit of the base currency.
Example: EUR/USD = 1.3115. This means that 1 euro (the base currency) is equal to 1.3115 US dollars (the quote currency).
Now take a quick peek at how the euro is doing against the Japanese yen: for 1 euro I can get 106.53 Japanese yen (i.e. EUR/JPY=106.53). Maybe I’ll wait until the euro gets stronger before I exchange it and fly to Tokyo again.
The exchange rate may change in 2 days or 1 week, though. It may even stabilize for a while. Okay, but when? If you’re a time freak like me, the when is important to you, too.
The when is a question that nobody can answer precisely. It depends on a great deal of social and economic factors, many of which you’ll be watching more closely when you start trading forex.
Why? Because currency rates change all the time, and you want to know when to buy one currency and when to sell another to make a profitable deal.
It is a market price that always consists of 2 figures: the first figure is the bid/selling price, and the second is the ask/buying price. (e.g. 1.23458/1.12347).
Also known as the offer price, the ask price is the price visible on the right-hand side of a quote. This is the price at which you can buy the base currency.
For example, if the quote on the EUR/USD currency pair is 1.1965/67, it means that you can buy 1 euro for 1.1967 US dollars.
It is the price at which you can sell a currency pair.
For example, if the EUR/USD is quoted at 1.4568/1.4570, the first figure is the bid price at which you can sell the currency pair.
Bid is always lower than ask. And the difference between bid and ask is the spread.
It is the difference in pips between the ask price and the bid price. The spread represents the brokerage service costs and replaces transaction fees.
There are fixed spreads and variable spreads. Fixed spreads maintain the same number of pips between the ask and bid price, and are not affected by market changes. Variable spreads fluctuate (i.e. increase or decrease) according to the liquidity of the market.
It is the currency you choose when you open a trading account with XM. All your profits and losses will be converted into that particular currency.
At XM you can open any kind of trading account you prefer with many base currency options: USD, EUR, GBP, JPY, CHF, AUD, HUF, PLN, or RUB.
So if you open an account in USD but you transfer funds in EUR, the funds will be automatically converted into USD at the prevailing inter-bank price.
A pip is the smallest price change of a given exchange rate.
Are you a visual type? Here’s an example: if the currency pair EUR/USD moves from 1.2550 to 1.2551, that’s a 1 pip movement; or a move from 1.2550 to 1.2555 is a 5 pip movement. As you see, the pip is the last decimal point.
All currency pairs have 4 decimal points – the Japanese yen is the odd one out. Pairs that include JPY only have 2 decimal points (e.g. USD/JPY=86.51).
It is an extra decimal place in the exchange rate. In the case of non-JPY pairs, we have 1.23456 instead of 1.2345, while in pairs that contain JPY, we have 123.456 instead of 123.45. We call the last decimal place in such pricing a pip fraction or tenth pip.
Forex is traded in amounts called lots.One standard lot> has 100,000 units of the base currency, while a micro lot has 1,000 units.
For example, if you buy 1 standard lot of EUR/USD at 1.3125, you buy 100,000 Euros and you sell 131,250 US dollars. Similarly, when you sell 1 micro lot of EUR/USD at 1.3120, you sell 1,000 Euros and you buy 1,312. US dollars.
The pip value shows how much 1 pip is worth. The pip value changes in parallel with market movements. So it is good to keep an eye on the currency pair(s) you are trading and how the market changes.
Now let’s reflect on what you have learnt about pips! To benefit from pips and see significant a increase/decrease in profit, you will need to trade larger amounts. Suppose your account currency is USD and you choose to trade 1 standard lot of USD/JPY. How much is 1 pip worth per $100,000 on the USD/JPY currency pair?
The calculation formula is as follows:
Amount x 1 pip = 100,000 x 0.01 JPY = JPY 1,000 If USD/JPY = 130.46, then JPY 1,000 = USD 1,000/130.46 = USD 7.7 Therefore, the value of 1 pip in USDJPY is equal to: (1 pip, with proper decimal placement x amount/exchange rate)
Here is another example:
In the EUR/USD pair, a movement from 1.3151 to 1.3152 is 1 pip, so 1 pip is .0001 USD. How much US dollar is this movement worth per $1,000 micro lot? 1,000 x 0.0001 USD = 1 USD.
Margin is the minimum amount of funds, expressed as a percentage, that you will need if you want to open a position and keep your positions open.
If you trade on a 1% margin, for instance, for every USD 100 that you trade, you need to put down a deposit of USD 1. And so, in order to buy 1 standard lot (i.e. 100,000 of USD/CHF), you need to maintain only 1% of the traded amount in your account i.e. USD 1,000. But how can you buy 100,000 USD/JPY with only USD 1,000? Basically, margin trading involves a loan from the forex broker to the trader.
When you carry out a forex transaction, you don’t actually buy all the currency and deposit it into your trading account. Practically speaking, what you do is speculate on the exchange rate. In other words, you estimate how the exchange rate will move, and you make a contract-based agreement with your broker that he will pay you, or you will pay him, depending on whether your estimation has proved to be correct or wrong (i.e. whether the exchange rate has moved in your favor or against your initial speculation).
If you purchase a USD/JPY standard lot, you don’t need to put down 100,000 USD as the full value of your trade. Instead, you will have to put down a deposit that we call margin. This is why margin trading is trading with borrowed capital. In other words, you can trade with a loan from your broker, and that loan amount depends on the amount you initially deposited. Margin trading has another big advantage: it allows leverage.
As you can see in our example, your initial deposit serves as a guarantee for the leveraged amount of 100,000 USD. This mechanism ensures the broker against any potential losses. Moreover, you as a trader are not using the deposit as payment, or to purchase currency units. Your broker needs a so-called good-faith deposit from you.
Strictly speaking, through leverage the forex broker lends you money so that you can trade bigger lots:
Leverage depends on the broker and its flexibility. At the same time, lLeverage varies: it can be 100:1, 200:1, or even 500:1. Remember that with leverage you can use $1,000 to trade $100,000 (1,000×100) or $200,000 (1,000×200), or $500,000 (1,000×500).
This sounds great, but how does it actually work? I open a trading account and I get a loan from my broker as simply as that?
Firstly, it depends on what type of account you open, what the leverage for that particular account type is, and how much leverage you need. Don’t be greedy – but don’t be too shy, either. Leverage can be used to maximize gains – but also losses, if you are too greedy.
Secondly, your broker will need an initial margin on your account, that is, a minimum deposit.
You open a trading account that has a leverage of 1:100. You want to trade a position worth $500,000 but you only have $5,000 in your account. No worries, your broker will lend you the remaining $495,000 and sets aside $5,000 as your good faith deposit.
The profits that you make by trading will be added to your account balance – or, if there are losses, they will be deducted. Leverage increases your buying power and can multiply both your gains and losses.
Always choose a broker that offers no negative balance protection, and so your losses will never exceed your capital. This means that if your loss reaches USD 5,000, your positions will be closed automatically so that you will not end up owing money to your broker.
It is the total amount of money in your trading account, including your profit and losses. For instance, if you deposited USD 10,000 into your account and you also made a profit of USD 3,000, your equity amounts to USD 13,000.
It is the amount of money kept aside by your broker so that your current trading positions can be kept open and you don’t end up with a negative balance.
It is the amount of money in your trading account with which you can open new trading positions.
Free margin = Equity – Used Margin.
This means that if your equity is USD 13,000 and your open positions require USD 2,000 margin (used margin), you are left with USD 11, 000 (free margin) available to open new positions.
Margin calls are a major part of risk management: as soon as your Equity drops to a percentage of the margin used, your forex broker will notify you that you need to deposit more money if you want to maintain your position. At XM this percentage is 50%.
Now that you’re not a complete beginner any more, let’s get down to calculating your profit (or loss).
We will take the USD/CHF currency pair. You want to buy USD and sell CHF. The quoted rate is 1.4525 / 1.4530.
Step 1: you buy 1 standard lot of 100,000 units at 1.4530 (ask price). Wait! In the meantime the price has moved to 1.4550, so you decide to close the position.
Step 2: you can see the new quote for your USD/CHF currency pair. It’s 1.4550 / 1.4555. You are already closing your position, but don’t forget that you initially bought a standard lot to enter the trade. Now you are selling in order to close your trade. You must take the bid price of 1.4550.
Step 3: you start calculating. What do you see? The difference between 1.4530 and 1.4550 is .0020. This equals 20 pips.
Do you remember our calculation formula earlier? You will be using it now.
100,000 x 0.0001 = CHF 10 per pip x 20 pips = CHF 200 or USD 137.46
Important! When you enter and exit your position, you must always watch the spread in the bid/ask quote.
As you learnt it before, you use the ask price when you buy a currency, and the bid price when you sell a currency.
It is a trade that you hold open during a certain period of time.
When you enter a long position, you buy a base currency.
Supposing that you choose the EUR/USD pair. You expect the EUR to strengthen as compared to the USD, so you will buy EUR and profit from its increase in value.
When you enter a short position, you sell a base currency. If you choose the EUR/USD pair again, but this time you expect the EUR to weaken as compared to the USD, you will sell the EUR and profit from its decrease in value.
Close a Position
If you enter a long (buy) position and the base currency rate has gone up, you want to get your profit. To do so, you must close the position.
Market Order / Entry Order
It is an order to buy or sell currency instantly at the current price.
It is an order to buy/sell a financial instrument (e.g. forex, stocks, or commodities like oil, gold, silver, etc.) that will stay open until you close it, or you have your broker close it for you (e.g. via telephone trading).
It is an order placed away from the current market price.
Assuming that EUR/USD is traded at 1.34. You want to go short (place a sell order on this currency pair) if the price reaches 1.35, so you place an order for the price 1.35. This order is called limit order. So your order is placed when the price reaches the limit of 1.35. A buy limit order order is always set below the current price whereas a sell limit order is always set above the current price.
It is an order that you give to buy above the current price or an order to sell below the current price when you think the price will continue in the same direction. It is the opposite of a limit order.
Let’s assume that EUR/USD is traded at 1.34. You want to go long (i.e. place a buy order on this currency pair) if the price reaches 1.35, so you place a stop-entry order to buy at 1.35. This order is called stop-entry order.
Take Profit Order (TP)
It is an order that closes your trade as soon as it has reached a certain level of profit.
Stop-Loss Order (SL)
It is an order to close your trade as soon as it reaches a certain level of loss. With this strategy, you can minimize your loss and avoid losing all your capital.
You can make stop-loss orders with automated trading software. It’s a great thing because even if you’re on holiday when you don’t watch how the market and currency rates change, the software does it for you.
It is the process of completing an order.
When you place an order, it will be sent to your broker, who decides whether to fill it, reject it, or re-quote it. Once your order is filled, you will receive a confirmation from your broker. Unlike other forex brokers, XM operates with a strict No Rejections and No Re-quotes policy.
It is crucial to have your orders executed quickly. If there is a delay in filling your order, it can cause you losses. That is why your forex broker should be able to execute orders in less than 1 second. Why? Forex is a fast-moving market – and many forex brokers don’t keep pace with its speed, or purposefully slow down execution to steal a few pips from you even during slow market movements.
A re-quote is an unfair execution method used by some brokers. It occurs when your broker doesn’t want to execute your order on the price you entered, and slows down execution for its own benefit.
How does this take place?
- You decide to buy or sell a currency pair at a certain price;
- You press the button to place your order;
- Your broker receives the order;
- You receive a re-quote notification on the trading platform you’re using;
- You can either cancel your order or accept a worse price.
How can you avoid re-quotes?
- Choose a forex broker with a no re-quotes policy;
- Place a limit order: inform your broker in advance that you are only open for placing an order at a certain price or better.
Now you have taken your first baby steps and learned to toddle around in the world of forex. And most importantly, you now know the basic forex terminology. It’s time to open a demo account and start practicing with virtual money. However, before you do that you have to make two important decisions: you need to choose a broker and a trading platform.
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