Getting familiarized with terms used in forex trading is essential to a trader’s success. Having these vocabularies at your fingertips will improve your chart reading skills. Additionally, you will be able to avoid common mistakes when executing trades.
Table of Contents
Common Terms Used in Forex Trading
1. Currency Pair
A currency pair is two currencies quoted together. You can say it is the quotation of one currency against the other. The first currency is known as Base Currency, while the second one is known as Quote Currency.
In the EURUSD pair, for instance, EUR is the base currency while USD is the quote currency.
2. Market Order
Market Order is an instruction that a trader gives a forex broker to open a trade instantly at the current exchange rate price or later if the exchange rate price reaches a given value when it moves up or down.
a). Buy Stop Order
This type of order triggers a buy position if the price moves up and reaches a given value. For instance, if the current exchange rate is at 1.18450 and you want the broker to automatically execute a buy position when price moves by 10 PIPs, you need to set a buy stop order at 1.18550.
b). Sell Stop Order
A sell stop order is the exact opposite of a Buy Stop Order. It triggers a sell position if price moves down and reaches a given value.
Considering the previous example, if the current exchange rate is at 1.18450 and you want the broker to automatically execute a sell position when the price moves by 10 PIPs, you need to set a sell stop order at 1.18350.
A PIP stands for Percentage in Point. It is the unit of measure in price movement.
If the exchange rate of the EURUSD pair is 1.18450 and the new value displayed after a given period is 1.18250, it means the value of EUR has gone down by 20 PIPs.
a). PIP value
PIP Value is basically how much in US dollars a PIP is worth. On a 5 decimal place currency pair such as GBPUSD, 1 PIP is written as 0.0001. To calculate how much the 1 PIP is worth, we divide 0.0001 by the exchange rate and then multiply the result by lot size. If you are trading a standard lot size, the calculation will be as follows:
(0.0001/1.18450) x $100,000 = $8.4424
From the calculation, if there is 1 PIP move towards your trade direction, you make $8.4424 as a profit.
4. Lot Size
Lot Size is the size of a trade you can open. You can call it a unit or a bale.
For example, in a food store, a trader handles bales of rice. In forex, a trader operates lots.
Four Types of Lot Sizes
- Standard Lot(Represents 100,000 units of currency)
- Mini Lot(Represents 10,000 units of currency)
- Micro Lot(Represents 1000 units of currency)
- Nano Lot(Represents 100 units of currency)
How Lot Sizes are represented
- A standard lot is 1.00 Lots
- A mini lot is described as 0.10 Lots
- A micro lot is defined as 0.01 Lots
- Nano lot is represented as 0.001 Lots
As a beginner in forex trading, set your Lot Size at o.o1 and forget about it. If you are experienced, consider these guidelines: Any amount from:
- $100 to $199, use 0.01 lot size
- $200 to $299, use 0.02 lot size
- $300 to $399, use 0.03 lot size
- $400 to $499, use 0.04 lot size
- $500 to $599, use 0.05 lot size
- $600 to $699, use 0.06 lot size
- $700 to $799, use 0.07 lot size
- $800 to $899, use 0.08 lot size
- $900 to $999, use 0.09 lot size
- $1000 to $1999, use 0.10 lot size
A Spread is a difference between the Sell price(also known as Bid Price) and the Buy price(also known as Ask Price). Forex Brokers make money by charging traders a commission or widening the spread. When opening a trade, you don’t need to calculate the spread manually because it is calculated automatically by trading software.
6. Account Balance
The Account Balance is the amount of money you have in your trading account. If you deposit capital of $1000, then your account balance will read $1000.
Your equity is the account balance if you don’t have any open trade. But if you have any open trades, your equity is account balance minus unrealized loss or account balance plus unrealized Profit.
Margin is the amount your broker deducts from your account balance and sets aside to keep your trade open. If your trade closes in Profit, the margin deducted from your account balance plus the Profit you have made is credited to your account. If the price hits your stop loss and you end up in a failure, the loss you incur is deducted from the margin, and the remaining balance is credited to your account.
9. Free Margin
An amount of money available for opening a new trade is known as Free Margin. If you have an account balance of $100 and you buy or sell EURUSD, your broker sets aside an amount from the $100 to maintain the open position. This amount set aside is known as the Used Margin. The remaining amount in your account balance is the Free Margin. You can use it to open another position.
10. Margin Level
It’s the representation of free margin in percentage. It shows how healthy your account balance is. Always make sure that your Margin Level is above 100%.
11. Margin Call
A margin call is a warning you receive from your broker notifying you that your free margin has gone below the required amount to keep the open trade running. It is something you don’t want to overlook.
To avoid a Margin Call, ensure you avoid trading highly volatile pairs such as AUDJPY, XAUUSD, etc, on a small account. In addition to that, make sure you employ proper Risk Management.
12. Stop Out Level
Stop Out Level is a predefined minimum margin to keep an open position running. If a price hits a Stop Out Level, the broker closes open positions starting from the one with the largest unrealized loss.
Leverage is a loan a broker lends a trader so they may be able to trade with a small account balance. As retail traders, we cannot make any tangible profit without leverage.
Initially, trading profitably was impossible without depositing a minimum balance of $10,000,000(which is equivalent to over one billion Kenya Shillings). Thanks to leverage, we can deposit as little as $5 in our trading accounts today.
The above terms used in forex trading are just a few of the Forex lingos you need to equip yourself with as a forex newbie. The vocabularies are not the only terms in forex; you will learn more about other forex vocabularies in your trading journey.
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