#4: Common Forex Trading Terminologies
What are the common trading terminologies?
This is for those of you who are brand new to Forex trading.
If you don't understand what's the meaning of long/short, pip, bid, ask, spread, and all of this all alien language to you, then don't worry…
This video will clear all your doubt, frustration, and confusion.
So, here’s what I’ll cover:
- Leverage & Margin
- Bid & Ask
Here we go…
To simply put it, long and short refers to your trade direction.
If a trader says something like, "Hey Rayner, I'm long EUR/USD!"
This means that the trader would make a profit if the price goes up.
It means the trader is bullish.
He wants the market to go up so he can make a profit.
And if someone says, "Hey Rayner, I'm short the GBP/USD!"
This means that he wants the market to go down because he will make a profit if the price trades lower.
So, this is the meaning of long and short.
Long means you're bullish.
Short means you're bearish.
You’ll make money if the market goes down for short.
And you'll make money if the market goes up if you're long.
Leverage & Margin
Leverage basically means how much larger can you trade relative to your account size.
I've seen people mentioning leverage like how much more you can borrow.
But I wouldn't really use the word ‘borrow’ down here.
Because when you are trading Forex, your broker is not really lending you any money.
It's just a term that refers to how much larger you can trade relative to your account size.
I'll just give you an example…
Let's say you fund your account $10,000.00, and your broker offers you a leverage of 1:50.
What this means, is that your broker will allow you to trade up to $500,000.00 worth of currencies, because he gives you a 1:50 leverage.
This is what it means…
Your broker isn't really going to physically or electronically lend you another $490,000.00 in your account.
It just means that you can trade up to $500,000.
This is what I mean by a 1:50 leverage.
If it's a broker that offers 1:100
You can trade up to $1,000,000.
Just take the leverage factor, and multiplied by the amount of cash in your trading account.
That's your leverage.
Now, what is margin?
Essentially, margin and leverage they are two sides of the same coin.
You can apply this formula, just take 100, divide by your leverage factor.
So earlier we spoke about a factor of 1:50, so your margin this over here is 2%.
What this means is that your broker requires you to put at least 2% margin in your account to be able to trade the 1:50 size that you want.
To put it simply, if you were to trade $500,000.00 worth of currencies, your broker requires you to put 2% of this amount in your account, which is equivalent to $10,000.00!
This is why I say they're pretty much two sides of the same coin...
Leverage, and margin.
And one thing to bear in mind is that leverage is a double-edged sword.
You can potentially make more money, with a higher leverage.
But at the same time, you can potentially lose more in a faster period of time, because all you need is just a small percentage move against you.
And you will lose a lot depending on how much leverage you're using.
When you are actually trading, I don't really consider leverage and margin when I'm trading.
Because when I'm trading, I always have my stop loss in place and from there on I can calculate the appropriate position size for my trade.
And even though I'm trading with high leverage, I won't use a huge chunk of my capital because the risk has been taken into consideration.
This is actually advanced stuff, so if you really want to learn more about leverage and margin you can go down and read this article that I've written.
Pip basically refers to the point in percentage.
It's the smallest price movement in the Forex market.
Now I would say there's a smaller price movement because there's something called the pipette, but it's not a very useful thing to talk about.
For most currency pairs, the pip is the fourth decimal place.
For the Yen pairs (JPY), it's the second decimal place.
This is something you have to know.
Let’s talk about EUR/USD.
Let's say EUR/USD is trading at 1.0012, and let's say it moves up to 1.0015.
So how many pips did this, did the market move for EUR/USD?
Just take 15, minus 12, and you realize that you move up by three pips.
For the Yen pairs, like USDJPY.
Let's say it's trading at 120.01, and it moves to 120.05.
How many pips did this market move?
It moved up to four pips.
Because for the Yen remember, I say that you have to look at the second decimal place.
Bid & Ask
What is a bid and ask?
This can be a little tricky because it depends on what market you're trading.
If you're trading the futures market, the bid and ask price means different compared to someone who is trading the Forex market.
Since we are dealing with Forex, I'll just explain it in-terms of the FX market.
The bid is basically the price that you can sell it.
The ask is the price that you can buy at.
One thing to know is that when you are trading Forex, there isn't exactly one price in the market.
It's always two prices; the bid and ask.
Let’s say you're getting EUR/USD.
The ask is at 1.0015
The bid is at 1.0014
If you want to sell EUR/USD right now, you will sell it at the Bid price.
If you want to buy EUR/USD right now, you'll buy it the Ask price.
Depending on your trade direction, you are being offered different prices when you're trading.
One thing to note is that the bid is always lower than the ask.
Since you already understand what is the bid and ask…
The spread is simply the difference between the bid and ask!
If the Dollar Canadian is trading at 1.1125, this is the ask, and the bid is 1.1122
What is the spread?
It’s three pips on USD/CAD.
Now you may be wondering…
"Hey, Rayner, why do I have to pay 0.1125 to buy and when I sell I can only sell at 0.1122? Why do I have to lose these three pips?"
Well simply put, your broker the market maker, needs to make a living as well!
This is the form of transaction cost that is being passed on to you.
They have to make a living, they can't just provide a free service!
Now that you understand this. Let's do a quick recap…
- Long and Short is the direction of your trade.
- The more leverage you trade with, the easier it is to blow up your account. But with proper risk management, leverage is pretty much irrelevant.
- A pip is a point in percentage. For most currency pairs, it's the fourth decimal place, for the Yen pairs, it's the second decimal place.
- The bid is the price that you can sell it, the ask is the price that you can buy at.
- The spread is just the difference between the bid and ask, and this is what your broker makes this form of transaction.