As in learning any new activity, you must master the jargon….especially if you want to win the favours of your heart’s chosen one. You, the new guy, need to know some terms at your fingertips before you make your first trade. You already know some of these terms, but it never hurts to revise a little
- 1 Major and minor currencies
- 2 The base currency
- 3 The quotation currency
- 4 The Pip
- 5 The “Pipette”
- 6 Bid Price (Bid Price)
- 7 Price of the request (Ask Price)
- 8 The spread of supply and demand (Bid/Ask Spread)
- 9 The quotation agreement
- 10 The transaction cost
- 11 Major currency with the US dollar (“Cross Currency”)
- 12 The margin
- 13 The leverage effect
Major and minor currencies
The eight most traded base currencies (USD, EUR, JPY, GBP, CHF, CAD, NZD, and AUD) are called “major” or “major currencies”. They are the most liquid and attractive. All other currencies are called “minor” currencies.
The base currency
The base currency is the currency at the top of the pair. The quotation currency indicates the value of the base currency in a pair. For example, if the USD/CHF proposes a rate of 1.6350, then a USD is worth 1.6350 CHF.
In the Forex market, the US dollar is often considered the base currency for valuing others, which means that these valuations are expressed as units of one USD against the other quote currency of the pair. Exceptions to this rule are the British pound, the euro, the Australian dollar and the New Zealand dollar.
The quotation currency
The quotation currency is the one occupying the second place in the pair. It is most often referred to as the currency in Pips and any missed profits or losses are expressed in this currency.
A pip represents the smallest price unit for a given currency. Almost all currency pairs are composed of five significant digits and most pairs have one decimal place after the first digit, such as EUR/USD equivalent to 1.2538. Thus, a single Pip is the smallest change to the fourth decimal place – 0.0001. Therefore, if the quotation currency of a pair is USD, a Pip is always equal to 1/100th of a cent.
The exceptions are for pairs including the Japanese yen where a Pip is equal to 0.01.
This is one tenth of Pip. Some brokers prefer to evaluate in fractions of Pips or pipettes, for more details in their quotations. For example, if the EUR/USD fluctuated from 1.32156 to 1.32158, it moved 2 pipettes.
Bid Price (Bid Price)
The offer is the price at which the market is willing to buy a given currency pair on the Forex market. At this price, the trader can sell the base currency. This price is visible on the left side of the quotation.
For example, on the GBP/USD quotation of 1.8812/15, the purchase price is 1.8812. This means that you can sell the British pound for $1.8812.
Price of the request (Ask Price)
The demand price is the price at which the market is willing to sell a given currency pair on the Forex market. At this price, you can buy the base currency. It is visible on the right side of the quotation.
For example, on the EUR/USD quotation at 1.2812/15, the selling price is 1.2815. This means that you can buy one euro for 1.2815 US dollars. The sales price (ask) is also called the demand price.
The spread of supply and demand (Bid/Ask Spread)
The spread is the difference between the price of supply and demand. The term “big figure quote” of resellers refers to the first figures of the exchange rate. These figures are often omitted by resellers. For example, the USD/JPY rate could be 118.30/118.34, but would be expressed verbally without the first three digits: “30/34.” In this example, the USD/JPY displays a spread of 4 Pips.
The quotation agreement
Exchange rates in the Forex market are expressed in the following format:
Base currency/Quotation currency = Offer/Demand
The transaction cost
The critical point of the spread on supply/demand lies in the transaction cost represented by its difference. Indeed, at each trade, it is a question of buying the base currency and selling the quotation currency or vice versa, in a transaction of the same size on the same pair. For example, in the case of the EUR/USD rate at 1.2812/15, the transaction cost is 3 Pips.
The formula for calculating the transaction cost is:
Transaction cost (spread) = Demand price – Tender price.
Major currency with the US dollar (“Cross Currency”)
A “cross currency” is a pair associated with the US dollar. These pairs often have unpredictable movements as the trader has most often initiated two trades with the USD. For example, placing a buy trade on the EUR/GBP is equivalent to buying the EUR/USD pair and selling the GBP/USD. These “Cross currency pairs” often require a higher transaction cost.
When you open a new margin account with a Forex broker, you must deposit a minimum amount of capital into this account. This minimum varies from one broker to another from $100 to sometimes $100,000.
Each time you execute a new trade, a certain percentage of the account balance will be reserved as initial margin necessary to hedge the trade based on the underlying currency pair, its current price and the number of units (or lots) traded. The lot size always refers to the base currency.
For example, suppose you open a mini account with a leverage of 200/1 or 0.5% margin. Mini” accounts trade on mini lots. Let’s assume that a mini lot is equivalent to 10,000 US dollars. If you were to open a mini lot, instead of having to provide the full 10,000 dollars, you would only need 50 dollars (10,000 USD x 0.5% = 50 USD).
The leverage effect
Leverage is the ratio of capital employed during a transaction to the required security deposit (margin). This represents the ability to control large amounts of US dollars on a security with relatively small capital. The levers vary radically from one broker to another, ranging from 2/1 to 500/1.
Now that you have been able to impress your entourage with your Forex jargon, how about telling them about the different types of orders?