FOREX EDUCATION: Everything You Need To Know About Forex Trading
Currency Acronyms and Abbreviations
Almost every country has its own currency and a good number of them can be traded. But only a few of the currencies are actively traded. The big 5 are the United States dollar (USD), Euro (EUR), Japanese yen (JPY), the British pound (GBP), and the Swiss franc (CHF).
All currencies around the world has an internationally accepted 3-letter ISO (International Organization for Standardization) code: The first 2 letters abbreviate the country name and the last is the name of the currency. For example: GBP- GB stands for Great Britain while P stands for Pound. USD- US stands for United States and D stands for the Dollar. Other countries that call their currency dollars include the Canadian dollar (CAD), the Australian dollar (AUD), and the New Zealand dollar (NZD). As you can see, each of this symbols end in "D", which designates the dollar name.
However, sometimes the country name or currency that is symbolized is not the most common name. Thus, the symbol for the Swiss franc is CHF, where CH stands for Confederation Helvetica, which refers to Switzerland, and MXN stands for the Mexican Nuevo Peso, even though the most common name for Mexico's currency is simply the peso.
Major and Minor Currency
Major currencies are the ones most commonly traded because of the amount of market activity it has. They include the United States dollar (USD), the Euro (EUR), the Japanese yen (JPY), the British pound sterling (GBP), and the Swiss franc (CHF). Some groups consider the Australian dollar (AUD) as a major currency, though it is often considered a minor. Other minor currencies include the Canadian dollar (CAD) and the New Zealand dollar (NZD).
USD - $
• Official currency of the United States of America
• Known as the United States Dollar
• Also called Greenback
• Most traded currency in the FX market at 90% daily transaction
• Largest reserve currency
EUR - €
• Official currency of the Euro Zone, used by 16 of the 27 Member States of the European Union (EU)
• Known as the European Union Euro
• Simply called Euro
• Second most traded currency in the FX market at 37.0% daily transaction
• Second largest reserve currency
JPY - ¥
• Known as the Japanese Yen
• Simply called Yen
• Third most traded currency in the FX market at 20% daily transaction
GBP - £
• Official currency of the United Kingdom
• Known as the Great Britain Pound
• Also called British Pound , Pound Sterling or Sterling
• Fourth most traded currency in the FX market at 17.0% daily transaction
• Third-largest reserve currency
• Known as the Confoederatio Helvetica franc
• Also called Swiss Franc
• Official currency of Switzerland and Liechtenstein
• Fifth most traded currency in the FX market at 6% daily transaction
• Know as Australian dollar
• Also called Aussie
• Sixth most traded currency in the FX market at 5% daily transaction
• Known as the Canadian dollar
• Also called the Loonie
• Seventh most traded currency in the FX market at 4% daily transaction
• Known as New Zealand dollar
• Also called Kiwi
Exotic Currency is currency that is not common in the foreign exchange market. These are usually from developing countries such as parts of Asia, the Middle East and Africa. Exotic currencies are not easy to trade because market activities for this kind of currency are very few. Exotic currencies are neither major nor minor but they are still very important in the Forex market.
Trading exotic currency trading is very different from trading major currencies because of the level of interest exotic currencies have in the market. The lack of activity in the exotic currency market means this type of currencies may have higher cost and may carry higher risk. Although high risk creates opportunities for high profits, traders should take into consideration that exotic currency market is not easy to understand and may not be secure. The political and financial environments in developing countries may change quickly and cause the country's currency to rise or fall in value.
|Azerbaijan New Manat||AZN|
|Costa Rican Colon||CRC|
|Cuban Convertible Peso||CUC|
|Dominican R Peso||DOP|
|East Caribbean Dollar||XCD|
|El Salvador Colon||SVC|
|Falkland Islands Pound||FKP|
|Ghanaian New Cedi||GHS|
|Mozambique New Metical||MZN|
|NL Antillian Guilder||ANG|
|New Zealand Dollar||NZD|
|Nicaraguan Cordoba Oro||NIO|
|North Korean Won||KPW|
|South African Rand||ZAR|
|Sri Lanka Rupee||LKR|
|St Helena Pound||SHP|
|CFA Franc BCEAO||XOF|
|CFA Franc BEAC||XAF|
|Cape Verde Escudo||CVE|
|Cayman Islands Dollar||KYD|
|Hong Kong Dollar||HKD|
|Israeli New Shekel||ILS|
|Papua New Guinea Kina||PGK|
|Peruvian Nuevo Sol||PEN|
|Romanian New Lei||RON|
|Sao Tome/Principe Dobra||STD|
|Sierra Leone Leone||SLL|
|Solomon Islands Dollar||SBD|
|Turkish New Lira||TRY|
|United Arab Emir Dirham||AED|
In the foreign exchange market, currency is listed in pairs, the base currency and the quote currency.
• The first currency listed in any currency pair is the base currency. Euro is the base currency in the EUR/USD pair
• The value of the base currency is always 1.
• It shows how much it's worth is as measured against the second currency.
• The currency in which the operating results of the bank or institution are reported.
• The base currency is quoted in units of the second currency, called the counter currency.
• The second currency listed in any currency pair is the quote currency. US Dollar is the quote currency in the EUR/USD pair.
• This is frequently called the pip currency or counter currency.
• Any unrealized profit or loss is expressed in this currency.
• The amount of the currency equal to a unit of the base currency.
• The base currency is quoted in units of the second currency, called the counter currency.
• It is an indicative price, which is the price quoted for information purposes but not to deal.
Currency is also traded in pairs. Pairs have meaning in relation to each other so they must always stay together. The two currencies in a pair are traded one against the other. The rate at which they are traded is called the exchange rate. The exchange rate is always changing. The value of one currency is determined by market supply and demand forces, by comparing it to another currency.
The rate of exchange is the amount of the foreign currency that is equal in value to a unit of domestic currency. In other words it is the amount of currency received for each unit of the currency tendered. In every transaction, money constitutes one side of the transaction. Buying a loaf of bread for 2 dollars is the same as selling 2 dollars for a loaf of bread. But when you buy currency, then both items exchanged are money. For instance, the Great Britain pound (GBP) is measured at $2 in value. That means that for American trading dollars for British pounds, he needs $2 to get £1, equaling an exchange rate of 0.5.
Base Currency/Quote Currency = Exchange Rate
Example: If GBP/USD = 2, then it takes 2 U.S. dollars to buy 1 British pound.
Quote Currency/Base Currency = 1/(Base Currency/Quote Currency)
Example: If GBP/USD = 2, then USD/GBP = 1/2 = 0.5; thus, 1 USD can be exchanged for 1/2 GBP.
Thus, a quote for GBP/USD is the number of United States dollars (USD) needed to buy 1 Great Britain pound (GBP), or how much USD would be received for 1 GBP.
Buy and Sell
When you buy a currency pair, you buy the base currency and sell the quote currency. The exchange rate tells buyers how much of the quote currency they need to buy one of the base currency.
The order in a currency pair is always the same. The order for USD/JPY will not change. So you either buy it or sell it, depending on the direction of the trade. For USD/JPY, you either buy JPY using USD or you sell JPY to get USD. If a trader buys EURUSD, they are using Dollars to buy Euros, while selling US Dollars.
If a trader were to sell EURUSD, they are using Euros to buy US Dollars, effectively selling Euros. EUR/USD 1.2500 means you need 1.25USD to buy one euro. It also means if you sell one euro you get 1.25USD. All trades involve buying one currency and selling another currency at the same time.
In this example Euro is the base currency and thus the "basis" for the buy/sell. If you believe that the US economy will continue to weaken and this will hurt the US dollar, you would execute a BUY EUR/USD order. By doing so you have bought Euros in the expectation that they will appreciate versus the US dollar. If you believe that the US economy is strong and the Euro will weaken against the US dollar you would execute a SELL EUR/USD order. By doing so you have sold Euros in the expectation that they will depreciate versus the US dollar.
In this example the US dollar is the base currency and thus the "basis" for the buy/sell. If you think that the Japanese government is going to weaken the yen in order to help its export industry, you would execute a BUY USD/JPY order. By doing so you have bought U.S dollars in the expectation that they will appreciate versus the Japanese yen. If you believe that Japanese investors are pulling money out of U.S. financial markets and repatriating funds back to Japan, and this will hurt the US dollar, you would execute a SELL USD/JPY order. By doing so you have sold U.S dollars in the expectation that they will depreciate against the Japanese yen.
Bid, Ask, Spread
Traders in the foreign exchange market buy and sell currency to try to make profit. There are two prices for a currency, the buy price or simply called "bid" and the sell price or "ask".
A bid price is the price that a buyer is willing to pay for a good or the highest price that the seller is offering for a particular currency at that moment. Ask price, also called "offer price", "offer", "asking price", is the lowest price acceptable to the buyer. In other words, it is the price a seller of a good is willing to accept for that particular good.
The difference between the bid and the ask is the spread. For example, if the bid price is $20 and the ask price is $21 then the "bid-ask spread" is $1.The Bid-Ask Spread, also known as the Bid-Offer Spread, represents the difference between what the market maker gives to buy from a trader, and what the market maker takes to sell to a trader. Together, the two prices constitute a quotation. The bid-ask spread is stated as a percentage cost of transacting in foreign exchange. The spread between the two prices arises as valuations differ, and transactions usually occur somewhere in the middle as one party changes the price they are willing to pay or accept in order to obtain or sell the good.
The Spread can also be defined as the amount by which the ask price exceeds the bid, the difference in price between the highest price that a buyer is willing to pay for an asset and the lowest price for which a seller is willing to sell it.
For example: the EUR/USD bid/ask rate is 1.2100/1.2200. The market maker gives $1.21 when buying from the trader, but takes $1.22 when selling to the trader. If traders buy and sell immediately without any change in the exchange rate, they lose money. This happens because of the spread - traders pay more to buy the currency than they receive when they sell in that one moment. In fact, the spread is the leading source of income for the market maker. Like any other market, the merchant will buy at one price and sell at a higher price.
The bid price and the ask price are never the same. The ask price is always a little higher than the bid price. A dealer makes money by buying at one price and selling a little higher. When the dealer sells, the trader is buying, and when the dealer buys, then the trader is selling. The trader pays the broker's ask price, and the trader sells to the broker for the broker's bid price, and the difference between the prices is called the spread, which in currencies, is usually at least 4 pips.
The bid price for the trader is always lower than the ask price, because that is how forex dealers make money. If one wants to buy currency, one has to pay the higher ask price, but if one wants to sell currency, one has to sell it at the lower bid price. So if you were to buy currency, then immediately sell it back to the same dealer, the dealer would make money, and you would lose money. Thus, the spread is the transaction cost of trading currency.
The usual spread for major currency is about 3 to 5 pips or more for major currencies, depending on the dealer. For less frequently traded currencies, or for major currencies during high volatility or low volume, the spread can be much greater. Many brokers advertise 2-pip spreads and you will rarely see spreads which are less than 4 pips.
The actual transaction cost is determined not only by the spread, but also by the lot sizes of currency trades. Most regular accounts trade in lots of 100,000 units, and so a pip is worth 10 units of currency. Most mini-accounts trade in lot sizes of 10,000 units, and so a pip is worth 1 unit of currency. If the quote currency is the USD, then a lot size in a regular account is $100,000 and each pip difference is $10. For a mini-account, a pip would be equal to $1. If the quote currency is other than USD, then the pip value would have to be converted if you wanted to know what your profit or loss in USD.
The price of a currency is called the quote. There are two forms of quotes in the Forex market namely the direct quotes and the indirect quotes. A direct quote is the price for one US dollar in terms of another currency. An indirect quote is the price for one unit of another currency in terms of the US dollar. In general, most currencies which are quoted against the USD is a direct quote while the EUR, GBP, AUD, NZD as well as Gold XAU and silver XAG are indirect quoted.
Volatility is the rate or the measurement by which the price of a currency moves up and down. The higher the volatility, the riskier the currency is. Conversely, the lower the volatility, the more stable the currency is. If the currency has low volatility this means that price almost never changes and may be steady over a certain period of time.
Pip or "percentage in point," refers to the very last digit of a currency price. It is 0.0001 of a unit. Pips are the smallest increment of price movement. The pip is the smallest value quoted by brokers and dealers.
Furthermore, given that the quote currency is valued as a unit of the base currency, this makes it easier to compare different currency values and changes in currency values. Since a large amount of currency is usually traded, a smaller unit of measure is convenient in expressing currency prices. This smaller unit is called a pip, which is equal to .0001 of the base currency for most currencies. In U.S. dollars, it is equal to 1/100 of a cent. Thus, 10,000 pips = 1 dollar.
For example: EUR/USD at 1.2635. If the sell price were to increase to 1.2636 we have a one pip increase. Should the EUR/USD sell price move from 1.2635 up to 1.2735, we say EUR/USD increased 100 pips.
In the example of EURUSD, one pip is worth 1/100th of a US Dollar cent. Most currency traders are concerned with relatively small movements in the forex market that is why they talk about the movement in terms of pips.
An exception to the value of the pip is the Japanese Yen. Because the yen has much less value than the United States dollar, a pip is considered to be only 1% of the yen. Although most currency quotes are expressed by 4 significant digits, the Japanese yen is just expressed by 2 significant digits.
Multiple shares held or traded together that are usually in units of 100. The standard unit size of a transaction is referred to as the lot.
Leverage and Margin
When a trader opens a position larger than the amount of funds required to open it, the trader has to put up a collateral to hold this position. This collateral is also called a margin which may also be called as the "good faith deposit". Once the trader has put down a margin he will receive a leverage. The amount of margin that the trader puts up will determine his leverage.
For example, a trader puts down $1,000 as a margin in order to control $100,000. In this case, the trader's leverage would be 100:1 because the trader controls one-hundred times what he put down. Likewise, his level of margin would be 1% because only 1% was required to open the larger position. For other cases, the trader may put down $500 to control $100,000. His leverage would be 200:1 while his margin percentage would be 0.5%.
|Leverage refers to the amount of money he controls relative to the margin.|
|Margin Required||Position Size - Notional Value||Leverage||Margin %|
In the Forex market only a margin deposit is required unlike in the other financial markets where a full deposit of the amount traded is required. Most brokers allow a 100:1 leverage or a 1% margin. This means that you can buy or sell $100,000 worth of currency while maintaining $1,000 in your account. The leverage could go as high as 400:1 depending on your risk profile and the broker. 400:1 leverage means that you will only need 1/400 in balance to open one position.
Most forex brokers allow a very high leverage ratio, or a very low margin rate. This is why profits and losses can be so great in forex trading even though the actual prices of the currencies themselves do not change all that much. Currency can never double or triple in price, or fall to zero. Because currency prices do not vary substantially, much lower margin requirements is less risky than it would be for stocks.