Foreign Exchange, commonly known as forex is one of the biggest industries in the world. Every day, forex transactions worth more than $5.3 trillion are made. This is much higher than the volumes of stocks that are traded every day. As a result, millions of people are interested in the industry. Sadly, data shows that only a very small percentage of people who become traders succeed. Part of the reason for this is that most of those people who start don’t have the experience and knowledge about the terminologies. In this report, we will explain the basic terms in forex you should know.
In forex, currencies are usually listed in pairs. This is simply because foreign exchange transactions happen between two currencies. For example, if you are traveling to Europe, you will need to exchange your dollars to euros. Examples of popular currency pairs are EUR/USD, GBP/USD, AUD/USD. In these pairs, the first one on the left is known as the base currency while the second one is known as the counter-currency. Therefore, when the EUR/USD chart moves up, it simply means that the euro is strengthening against the dollar.
A pip is a short form of the term point in percentage. It is the smallest unit in which a currency pair can move. For example, if the EUR/USD pair moves from 1.1200 to 1.1201, the 0.001 movement is equal to one pip. Some brokers quote their currency pairs above the 4 standard decimal points. In this case, the difference is known as the pipette or a fractional pip.
A good way to explain the term leverage is to consider a stock investment. Assume the stock price of company A is trading at $20 and you have $1,000 to invest. If you believe the stock will go up to $25, you can buy it. In this case, you will have 50 shares. If the stock reaches your target price, your total holdings will be worth $1250. Alternatively, you can borrow another $1,000 to invest. In this case, you will have 100 stocks. If the price reaches $25, your holdings will be worth $2,500. After returning the borrowed $1,000, you will have a profit of $500. In forex trading, leverage works in the same way.
Margin is a popular term in forex trading and is often confused with leverage. Margin is the amount of money that you need to use the leverage. It is a good faith deposit that you need to deposit with your broker. When there is a margin call, it means that the broker will stop the trade when it makes a bigger loss than they are willing to cover.
Traders use several tools to predict how currencies will move. Fundamental analysis is the process of looking at the market data to predict how a currency pair will move. Some of the popular fundamental analysis data used are interest rates, employment data, inflation, and manufacturing data. For example, if traders think that US rates will rise, it could be an indicator of a strong dollar.
Technical analysis is the other popular method in which traders use to analyze currency pairs. In it, traders use a combination of technical indicators to predict how the price will move. Some of the most popular indicators are moving averages, relative strength index, and MACD.
Bearish and Bullish
As you get into trading, you will come across these terms. They are simple. Being bearish is believing that the price of a currency pair will decline while being bullish is believing that the price will move upwards.
Hawkish and Dovish
These are two terms you will experience as a trader. They are mostly used in monetary policy circles. When officials are hawkish, it means that they believe that interest rates should move up. If they are dovish, they expect interest rates to move lower.
Currency Majors, Minors, and Exotics
Currency majors are those pairs from developed countries. They must have the dollar either as the base currency or as the counter currency. Examples of majors are EUR/USD, GBP/USD, and USD/JPY. Minors are currencies of other developed countries. Examples are AUD/NZD, GBP/CAD, and EUR/GBP. Exotics are currency pairs of emerging market currencies. Examples are USD/TRY and USD/ZAR.
A carry trade is one that takes advantage of low-interest rates in one country and higher rates in other countries. For example, if interest rates in Japan are at -0.20% and those from the US are 2%, traders can buy the low-yielding currencies and invest them in high-yielding currencies.
This is a trading strategy where traders buy and sell two currency pairs that are negatively correlated. For example, if the EUR/USD and GBP/USD pairs move in a similar direction, a trader can buy the EUR/USD pair and short the GBP/USD pair. In this case, if the trade works out perfectly, their profit will be the spread between the two.
Take Profit and Stop Loss
A stop loss is a tool that stops a loss-making trade automatically when a certain level is reached while a take profit is a tool that stops the trade automatically when a profit level is reached.
Final Thoughts on Basic Terms in Forex
Forex trading is an exciting business that can make you a lot of money. In fact, many people make loads of money by being forex traders. Having a good understanding of these – and more – terminologies will help nurture your trading skills.