Currency Pair
Any trade is basically an exchange. You exchange one product for another, buy a product for money, or, as happens in Forex, buy one currency for another. This trading instrument is called a currency pair. Any pair consists of two parts:
- Base currency. That’s the first half of any pair. That’s the currency you will buy or sell.
- Counter-currency. The second half of the pair. With it, you will purchase the base currency.
Forex trading works the following way:
- When opening a sell trade for the EURJPY pair, you sell the euro and buy the Japanese yen.
- When making a buy transaction for the same pair, you simultaneously purchase euros and sell the yens.
Currency Pairs Types
There are three types of currency pairs on Forex:
- Majors. These are currency pairs that always include the US dollar (USD). The second currency in this case is one of the most traded currencies in the Forex market. These include Euro (EUR), British Pound (GBP), Japanese Yen (JPY), Swiss Franc (CHF), Canadian (CAD), Australian (AUD), and New Zealand (NZD) dollars.
- If the pair includes the currencies from the previous paragraph but doesn’t contain the US dollar, then such a currency pair is called a cross pair.
- There are also exotic pairs. They include any currencies other than majors. Examples include Mexican Pesos (MXN), Chinese Yuan (CNY), Indonesian Rupiah (IDR), etc.
All novice traders should start with the majors. They are characterized by the lowest costs (narrow spread) and a good level of liquidity. Exotic pairs typically include high costs and extremely high levels of volatility. They should be postponed until later, when you gain at least some experience in trading.
Quotes or Quotations
This is the cost of the base currency in a counter-currency. Other titles you might face are price and exchange rate. If the currency quote for USDJPY is 110.80 then you need 110.80 Japanese yens to buy one US dollar.
If quotes are growing, then this can mean one of two things:
- The base currency is strengthening and its value is growing.
- The counter-currency is weakening and its value is falling.
Bid/Ask
This one is super simple. All trading instruments always have two prices simultaneously:
- Bid - purchase price
- Ask - sale price
These are the same prices you see at currency exchange points in any bank.
Spread
Spread is the difference between Bid and Ask prices. This is the price you will pay the broker every time you open a transaction. If you open many trades daily, pay attention to the size of the spread. Remember also that spread, even if it is fixed, can expand, for example, during the release of important economic news.
Pip and Lot
The smallest step in price movement on the market is a pip or point. You will calculate your profit once you know the value of one pip for your particular trade. For most currency pairs, the pip is the fourth digit after the decimal point. For some, like the Japanese yen, it is the second one.
Let’s take a look at these two examples:
- If the price has moved from 1.9870 to 1.9860, then it has changed by 10 pips
- Growth from 108.15 to 108.40 for USDJPY means a movement of 25 pips
The majority of trades on Forex is conducted in standard lots. One lot is equal to $100,000. So, if you open a transaction of 0.1 lot size, then your transaction has a volume of $10,000.
Some brokers provide trading opportunities in smaller lots:
- Mini-lot - $10,000
- Micro-lot - $1,000
Leverage
Of course, not everyone can open a trade even in one tenth of a standard lot. Where can a novice trader get $10,000? This is where a broker comes into play offering you a trading leverage.
Basically, the broker offers you a loan. If the leverage is 1:500, then you can open a trade 500 times larger than your actual investment. In this situation, in order to open a trade of $10,000 you will need only $20.
The main benefit of leverage is the ability to increase your profits tenfold. However, this can also be a disadvantage. If the market moves against you then you risk losing a significantly larger amount. You need to choose the size of the leverage wisely.
This must be enough for today. We will call this the first issue in a series of similar articles. Next time we will consider some more indispensable basic terms that will become the basis of your knowledge about Forex.