6 Key Terms You Need to Know Before You Start Forex Trading

Ever since the trading trend started, it seems like many people are so eager to jump into the forex trading profession. This does not come as a surprise because who wouldn’t want to earn money from the comfort of their own homes? Many articles, YouTube videos, and even ads online seem to hype up this particular profession too.

Although a lot of people indeed make a living out of trading forex, it takes a lot of practice, knowledge, discipline, and patience to get to their level. You can’t just jump in with both feet and invest your hard-earned cash on a forex pair just because it seems like a good idea. Just like learning how to do anything in general, you have to go through the basics.

If you want to learn how to trade Forex, you have to familiarize yourself with the six common trading terms used in the forex trading world:

  • Slippage
  • Volume
  • Leverage
  • Margin
  • Spread
  • Pip

This article will go through these terms one by one and explain their meaning and how they work.

Slippage

Slippage occurs when the value during which your order is performed differs from the value at which it was placed. Whenever the market moves against your trade and the initial pricing specified is not available during the time it takes your broker to complete the order.

This particular occurrence can happen at any time because of the market’s excessive volatility. High volatility in the market means the prices of the assets can either go up or down unexpectedly. If the price moves too quickly, there is a chance that your trade won’t be closed in time. This means the stop that you set at a certain price might not get triggered. 

Another reason slippage can happen is because of the market gap. A market gap occurs whenever the market quickly goes up or down with a few or no trades. 

Here’s an example of slippage. Let’s say you opened a short position on a major currency pair (GBP/USD). You have your stop loss set to 1.340. You check the price on Friday evening before the market closes for the weekend, and you see that it is sitting at 1.330. But over the weekend, you read a breaking news article, and this event forced the forex market to suddenly surge upwards.

As soon as the forex market opens on Sunday night, you check the price of the GBP/USD pair, and it’s already 1.350, which is over your set stop loss. This means your set stop loss, which is 1.340, is no longer available. So your executed trade’s stop loss will be fulfilled at the new price, which is 1.350.

Volume

Volume in trading refers to the quantity of a certain asset traded during a given time period. It is frequently displayed with information on its price since it adds another level to studying an asset’s market history.

Volume is the term used when measuring online assets like Forex, commodities, options, futures, stocks, and bonds. But volume is mostly used in share trading. As the name suggests, volume refers to the number of shares being traded.

Volume is a popular and very helpful tool in market technical analysis since it adds another dimension to evaluating an asset’s price history. It assists in determining the extent of price fluctuations. A price shift that is accompanied by a comparable rise in volume is considered to be more important than one that is not.

Every time an asset is traded, there must be a buyer and a seller to execute the trade. Each transaction is an individual exchange that contributes to the asset’s trading volume. Keep in mind, however, that the number of individual transactions is not what is being tallied in the trading volume. Instead, it is the number of assets traded that is being counted. 

In trading, if a market is labeled as “active,” it suggests that the trading volume of the assets in that market will be particularly higher than normal. If a market is labeled as “inactive,” it is safe to assume that the trading volume of the assets present in that market is lower. 

Now, if the market is volatile and there are substantial price fluctuations, the trading volume is generally on the higher end. 

Leverage

Leverage refers to the funds borrowed by a trader from their broker to increase their trading position. The use of leverage is typically available when trading several assets like Forex and CFDs. Trading with the use of leverage is called margin trading. 

When a client uses leverage when they open or execute a trade, the broker will only ask for a percentage of the full cost of their desired position. The broker then loans you the rest of the amount. 

For example, a trader only has $100 on their account, but they want to invest at least $200 on a certain asset. If the broker allows the use of leverage and only requires 50% of the amount, the trader can open a position worth $200 with only $100. The broker then provides the other $100.

Although the use of leverage can amplify your profits, it is considered a double-edged sword because it has the potential to amplify your losses as well. This makes trading a lot riskier. You need to calculate your risks and implement risk management strategies before you use leverage when trading. 

Margin

Margin is the term brokers use for the number of funds required for a trader to open a trading position with leverage. There are two kinds of margins when it comes to forex trading. These are initial or deposit margin and maintenance margin. The initial or deposit margin refers to the deposit amount required by a broker for you to be able to execute a trade or open a position. 

On the other hand, the maintenance margin is the additional funds that you will need to add to your account if your initial margin is not enough to keep your trade open. You will be notified by your broker that your funds are not enough to maintain your position, and they will put you on a margin call. Once this happens, you will then be prompted to add more money to your account. 

The great thing about margin is this it allows traders to use leverage when trading. Here’s an example of the usage of leverage. You want to invest $500 in a certain forex pair. If you are entitled to use leverage, you won’t need to shell out the full $500. If the broker only requires 50% as your margin, then you will only need to provide $250.

Another advantage that margin provides is traders stand to gain more from their winning trades. With the use of margin, any amount you gain from your trades is calculated from the full amount invested, including the leverage provided by the broker, not only from your initial or deposit margin. 

However, margin can also multiply the amount that you lose if the market prices move against your trade. The same mechanic applies. The amount you lose is calculated from the amount that you invested as well as the amount provided by the broker as leverage. This is why you should familiarize yourself with risk management strategies before you decide to trade with leverage. 

Spread

Spread in forex trading has a wide range of meanings. But generally, it is the difference between two rates or prices. Specifically, it is the difference between buying and selling prices of a particular asset, also known as the offer and bid prices. 

A majority of providers or brokers quote their pricing as a spread. This is why the buying price of an asset is a bit higher than its market price. Also, the price of the asset when it is being sold is also lower than the underlying market.

When a trader is dealing with spread-based assets, they keep their fingers crossed that the market price will rise above the spread price. If this occurs, it indicates that they can close the trade and make a profit. Even if the market moves in the anticipated direction, if the price does not rise above the cost of the spread, the trader may be forced to exit their position at a loss.

Bid-offer spread

Another term that you should familiarize yourself with is bid-offer spread. Bid-offer spread refers to a particular asset’s supply and demand. A tight market exists when the bid and offer prices are close to one other, indicating that buyers and sellers agree on how much the item is worth. If the spread is larger, it indicates that there is a big difference of opinion.

Three factors can impact the bid-offer spread of an asset. These are volume, liquidity, and volatility.

Volume

This is known as a way of recording the total sum of a daily traded asset. Products with a larger trading volume typically have smaller or tighter bid-offer spreads.

Liquidity

This term describes the ease with which an asset may be sold or purchased. The bid-ask spread often narrows as an asset’s liquidity grows.

Volatility

This is referred to as the measurement of how much the price of a certain asset varies over a specific time period. The spread is significantly wider during periods of high volatility, where prices tend to shift quickly.

Pip

In forex trading, a pip is a unit of measurement that is used to indicate the increase or decrease in value between two specific currencies. The technical definition of pip is “point in percentage.” It is the tiniest regulated move by which a currency quotation may vary. Traders use pips to compute the spread between the buy and sell price of a forex pair. It is also used to quantify the gain or loss made by a trader’s position.

As a measure of market price change, the spread in a currency pair can be reported in pips. A pip is the equivalent of a ‘point’ of movement.

Pip value

This refers to the value assigned to a move in a forex trade that only consists of one pip. However, this varies per currency. The pip value is the price assigned to a one-pip move in a forex deal, which varies per currency. Since most major currency pairings are quoted to four numerical places, a pip is often the fourth figure following the decimal point.

However, some exceptions exist. An example is the Japanese Yen. This specific currency is only priced in two numerical places. The pip is the second digit following the decimal point in these circumstances. Although most currency pairings are priced to two or four decimal points, some brokerage firms show an extra decimal. This is referred to as a micro pip or a pipette.

Frequently Answered Questions

What does Forex mean?

Forex comes from the words “foreign currency” and “exchange.” It is also sometimes referred to as FX.

What is Forex Trading in simple terms?

In simple terms, forex trading is the act of converting one currency to a different one. Here is the simplest form of forex trading.

Let’s say you are from the United States and you decided to travel to Japan. Once you land in Japan, you head to the currency conversion station and hand the staff $10,000. After some calculation, the staff will hand you back that amount in Japanese Yen.

Can you trade forex long-term?

Yes, you can trade forex long term. You can choose to hold your position for as long as you wish. But this is not always a good strategy. You have to check on your position every now and then. This is to get the necessary information that you need to make a decision as to whether you should hold your position or close the trade.

What is a forex pair?

A forex pair, also known as a currency pair, includes a quote currency or a counter currency and a base currency. These forex pairs are represented by the shortened currency name, which is divided by a slash.

An example of a forex pair is GBP/USD. GBP refers to the Great British Pound, and USD is the United States dollar.

What are major forex or currency pairs?

Major forex or currency pairs are two major currencies paired together. These major currencies are the Canadian Dollar, the Australian Dollar, the Great British Pound, the Japanese Yen, the Euro, the Swiss Franc, the New Zealand Dollar, and the United States Dollar.

In total, there are seven major currency or forex pairs. They are as follows:

NZD/USD or New Zealand Dollar/United States Dollar
USD/CAD or the United States Dollar/Canadian Dollar
AUD/USD or Australian Dollar/United States Dollar
USD/CHF or the United States Dollar/Swiss Franc
GBP/USD or Great British Pound/United States Dollar
USD/JPY or the United States Dollar/Japanese Yen
EUR/USD or Euro/United States Dollar

What does bearish or bullish mean in forex trading?

The terms bearish or bullish are used to define a trader’s opinion on a certain currency. These terms come from the movement of a bear and a bull when they attack, hence “bearish” and “bullish.” When bears attack, they typically stand up, raise their paws, and bring them down. A bull’s attack movement, on the other hand, starts from the bottom and ends at the top.

If a trader is bearish towards a currency, let’s say the Great British Pound or GBP, this means they have a negative outlook on it, and they think that its price will go down.

Alternatively, if a trader is bullish, this means their outlook on the asset is positive, and they are predicting its price to go up.

What kind of forex pairs can I trade?

There are four kinds of forex pairs that can be traded. These are major pairs, minor pairs, exotic pairs, and regional pairs. However, keep in mind that not all these forex pair types are offered by every single forex broker. Typically, only major and minor pairs are available. Make sure to check if the broker you are partnered with offers exotic or regional pairs if you wish to trade these.

How much money is needed to start forex trading?

The amount really depends on the broker. Some companies only require a dollar for you to start trading. Others might need at least $20 or $50. But don’t expect to earn a lot if you only invest the minimum deposit required.

Keep in mind that the more money you invest in Forex, the more you can possibly gain. A good amount for beginners is at least $100. You can gradually increase your investment once you get more confident with your trading strategy.

Is forex trading risky?

Any kind of trading is risky. However, there are ways to minimize risk when trading Forex. Make sure to study the market thoroughly before you open a trade. It’s also a good idea to only invest what you can afford to lose. Lastly, check out the different risk management strategies being used by other forex traders. Apply those strategies every time you open a position.

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