Essential Forex Terms You Need to Know

Base Currency/Quote Currency

The leftmost/first currency mentioned in a currency pair in the forex market is referred to as the "base currency". In a currency pair, base currency appears first and then the quote currency is displayed. Base currency shows the amount of the quote currency needed to buy one unit of the base currency. In the example given below, when a trader is trading the EUR/USD pair, the US Dollar (USD) = the quote currency at 1.0029. Similarly, the Euro (EUR) = the base currency at 1.0017. Acquiring 1 unit of the base currency requires the purchase of 1.0029 units of the quote currency.

Bid Price

Bid price is the amount of money that a trader offers to sell a particular currency pair. The bid price is usually listed as the first figure in price quotes on trading platforms and is always less than the ask price. Buyers transact at the ask price, while sellers engage at the bid price, establishing a fundamental dynamic in currency exchange transactions.

Here, the bid price is 1.0017, which means that if a trader wants to sell the pair, they’ll be selling it at the rate 1.0017.

Ask Price

The bid price is the price at which a trader sells a currency pair; it is typically the first price that is displayed on trading platforms. It consistently remains lower than the ask price, which is displayed on the right side of the price quote, as seen in the example with a rate of 1.0029. Must be wondering, why is the ask price higher than the bid price? When selling the pair at 1.0017, the counterparty ensures they do not incur a loss by reselling it back at an increased rate, represented by the ask price. Buying any currency pair requires a larger sum of money. 

Let's look at a real-world example: a retailer pays $5 for a pen that the producer sells. The merchant needs to charge more than $5 for the pen in order to make a profit. The dynamics of currency pairs in trading are mirrored in this notion.

Spread

The spread is the amount that separates the ask and bid prices i.e., the difference between the two. As spreads vary from one forex broker to another, choosing a reputable broker is crucial. Ever wondered why you always start at a loss whenever you enter a trade? The bid-ask spread between the two currencies is the reason for this. Brokers distinguish themselves from one another in this way. In comparison to other brokers, they aim to provide their clients with a smaller spread. The liquidity of the instrument being traded influences the changes in the forex spread. Low-liquidity currencies usually have higher spreads since fewer traders are trading them. Due to the lesser number of traders, the spread is wider. 

Conversely, more liquid and volatile currencies typically have narrower spreads as the number of traders is more. Spreads mostly affect traders who prioritize short-term gains and make quick transactions. Spreads have less impact on long-term traders because their main goal is to exit the market only when they have made significant profits.

Pips

A pip is the unit of measurement used to represent the change in value between two currencies. The term "percentage in point" is shortened to represent the smallest amount that can cause an exchange rate to rise or fall. In the above example, the difference between the bid and the ask price is expressed in pips i.e., 0.0012 pips. Another example is that if USD/JPY’s rate is 0.0013 and it increases to 0.0017, then it can be said that the increase is 0.0004 pips or 4 pips.

Leverage

Leverage helps traders in opening positions larger than the ones they could open with their initial capital. Different brokers offer different leverages. A trader's account size will be magnified to one hundred times the deposited amount, for example, if the leverage ratio is 100:1. Thus, trading with $5000 would inflate their account size to $500,000. While leverage can amplify profits, it also heightens the risk of rapid capital depletion. Consequently, traders are advised to exercise caution and avoid being lured by the allure of high leverage ratios.

Lots

Trading in forex includes dealing in predetermined quantities called lots. Lots indicates the number of currency units a trader has purchased or sold. A typical lot size is 100,000 currency units; smaller lots, micro lots, and nano lots are made up of 10,000, 1,000, and 100 units, respectively. That means that 1 lot is equal to 100,000 units. Traders who have more money would usually go for larger lots as more capital is needed to buy more lots. Whereas fewer funds would be needed to buy smaller lots. Even the tiniest price movement can have a big impact if the lot size is high. Similarly, even if there is a big price movement, it will have less impact if the lot size is low. 

Hence, if the quantity is low, the movement has to be high. Traders must choose the lot size really carefully to reduce risks and maximize profits. For example: new traders should begin their trading journey by indulging in smaller lots and increasing the lot size as the experience and confidence increases.

Margin

Brokerage firms set aside an amount of money to cover the losses of its traders, this amount of money is known as margin. For example, when the leverage ratio is 100:1, a trader holding a $200,000 account would only need to deposit $2000 as margin. When a trader executes successful trades and decides to withdraw their profits, the margin is returned along with the total earnings. On the other hand, if losses occur, the $2000 deposit is forfeited. In a scenario where a trader purchases a currency pair like USD/JPY, a portion of the margin is utilized. Upon closing the trade by selling the pair, the previously allocated margin is released. However, if the trade results in a loss, the frozen margin is lost and not reinstated into the total margin. 

Each trade necessitates a certain amount of margin to be locked. Consequently, engaging in numerous trades simultaneously could deplete the available margin. Crossing the margin limit prompts traders to either inject additional funds into their accounts or close some ongoing trades to free up frozen margin. The margin level during trading is maintained at 100%; nearing 100% restricts the number of trades that can be opened, while moving away from 100% permits increased trading activity.

Slippage

Slippage is a trading term used for the difference that frequently occurs between the anticipated trade value and the actual execution value of a trading order. When dealing with higher trading volumes, this difference becomes more noticeable. Due to the variations in market pricing, slippage can occur in the short period of time that passes between the initiation and completion of a trade order. Slippage is very less to zero in highly volatile currency pairs. Whereas slippage is high in less volatile currency pairs. 

Slippage can turn out to be profitable or can make a trader incur losses. Selecting currency pairs that are frequently traded can help in reducing the likelihood of slippage.

Bullish/Bearish

A bullish market is a market where traders feel positive about the market going up. This positive emotion is caused due to a number of factors which they think will affect the nation's economy favorably. These factors include economic expansion, rising stock values, and rising currency values. Traders acquire forex pairs in bullish markets with the goal of selling them when they think the market has reached its top. This is known as the "buy low, sell high" strategy.

A bearish market represents a negative view held by traders who anticipate market downfall. A bear market can be caused by negative economic causes such as stock price declines, currency depreciation, or economic downturns. When the market is bearish, traders may decide to sell their currency pairs and wait for the market to fall to buy them back at a reduced price, or they may decide to pause trading until they determine the bottom of the market before making any purchases.

Given that forex trading involves trading currency pairs, there will always be one currency that is strengthening and the other currency that is weakening, in a currency pair. Bullish markets evoke optimism and confidence among traders, while bearish markets tend to instill caution and negativity. It is imperative for traders to possess a comprehensive understanding of these market dynamics to make their trading decisions effectively.

Hindsight

Are your concepts clearer now? 

Head to Equitio's academy section for more lessons and video lessons. Doesn't matter if you are a beginner trader or an experienced professional, if you are passionate about trading and want to learn more, access our academy section. You know what is the best part? It is for free! Yes, learn unlimited without making a hole in your pocket. 

Being aware of these fundamental forex phrases is only the first step towards being a profitable trader. You'll come across even more jargon and ideas as you develop and learn more about trading. Never stop grasping information, be knowledgeable, and keep an eye on the market. You'll be able to easily navigate the forex terrain with time and experience!