Understanding Basic Terms in the Forex Market

A forex market refers to an over the counter market that allows traders, banks, institutions and individual investors to speculate, buy and sell currencies from different countries. Typically, the investors and speculators trade over the interbank market. It is an online channel that allows traders to purchase and sell currencies on a 24/7 basis for five days in a week. The market has a global turnover of US$5 trillion and is considered one of the largest markets in the world. But to succeed to trade on this market, you need to understand the following basic terms.

Calculating the Exchange Rate

You should be able to tell how much it will cost you to exchange currency for another. The rates are not constant, and so they keep on changing depending on activities at the forex market. For instance, you may want to use a calculator from Investors Hangout to check the exchange rate between the U.S dollar and the Canadian dollar. It will help you know the entry points and decide whether to choose short term or long term trades.

Currency pairs

To transact on the forex market, you need to pair two currencies. You will use one currency to buy or sell the other currency. For instance, you can trade in EUR/USD, GBP/USD, or AUD/CAD.  Thus, the act of choosing any two currencies to trade in is referred to as pairing the currency

Bid Price

It is the price at which one is willing and ready to buy a pair of currency. The Bid price keeps on changing depending on what is happening at the Forex market. Notice that forex prices will always be quoted in four decimal places. The reason for doing this is to take care of the spread differences which are always very small.  Notice that a single trade on the forex market can be worth millions; thus you can end up with a huge profit even where the difference in the biding and asking price are small. It also means that you can make a significant loss even when the spread is small.

Trading positions

Long Position- the term position refers to trade in progress. When a trader is said to have taken a long position, it means that he has bought the currency while expecting its value to go up. If he sells the currency back at a higher price, the difference is his profit, and the long position is closed.

Short Position- a trader is said to take a short position when he sells a currency because he expects its value to decrease. The trader plans are to buy the currency at a lower value. When he buys back the currency at a reduced value, the trade is said to be closed.

Other terms

Major pairs- are commonly traded pairs and may account to over 80% of the volume traded on the forex market. Also, they are less volatile.

Crosses- are currency pairs that exclude USD. Also, they are referred to as minor currency pairs e.g. GBP/JPY, EUR/JPY, EUR/GBP

Exotic - are currencies from smaller countries