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The Forex market: How does this work?

Welcome to the Forex trading world. Forex is the biggest market in the world. Forex traders exchange $4 trillion every day, but is Forex a favorable market for you? Forex (FX) is the marketplace where different national currencies are traded. The Forex market is the world’s largest and most liquid market, with trillions of dollars bought and sold every day.

The Basic Terms Used In Forex 

Currency Pair 

It is a quotation for one unit of a currency against another currency unit.

For instance, the euro and the US dollar combined make up the EUR / USD currency pair. The first currency (EUR) is the base currency, and the second currency (the US dollar) is the quote currency.

Exchange Rate 

This is the rate at which one currency is exchanged for another. The exchange rate tells you how much of the quotation currency you need if you’d like to buy 1 unit of the base currency.

Example: EUR/USD = EUR 1.3117. This means that 1 euro (base currency) is equivalent to 1.3117 US dollars (basic currency).

Currency of Account

It’s the currency you want when you open a Forex trading account. Each of the profits and expenses will be transformed into a single currency.

You can open any form of trading account you want with a range of standard currency options: USD, EUR, GBP, JPY, CHF, AUD, or RUB.

So if you set up an account in USD then pass funds in EUR, the funds will be transferred directly to USD at the prevailing interbank rate.

Fractional pips

It’s an extra decimal place in the currency rate. In the case of non-JPY sets, we have 1.23456 instead of 1.2345, and in pairs containing JPY, and we have 123-4.56 instead of 123.45. For such pricing, we call the last decimal place a pip fraction or a tenth pip.

Quote 

This is a retail price that often consists of two figures: the first figure is the bid/sell price, and the second is the ask/buy price. (e.g., 1.23457/1.12346) for example.

Ask price

Often known as the price of the deal, the selling price is the price evident on the right side of the quote. That is the quality at which you can buy a base currency.

For example, the quote on the EUR / USD pair is 1.1964/66, which means you can buy 1 euro for 1.1966 US dollars.

Price of bid

That is the price at which a currency pair may be exchanged.

For instance, if EUR / USD is quoted at 1.4567/1.4571, the first number is the bid price at which the pair will be exchanged.

The bid is often less than ask. So the difference between the bid and the asking price is the spread.

Spread 

It is the difference in the pips between the asking price and the bid price. The difference reflects the cost of the brokerage service and substitutes the transaction fees.

Pip 

A pip is the smallest increase/decrease in the price of a given exchange rate.

Are you a visual person, huh? Here’s an instance: if the currency pair EUR / USD goes from 1.2550 to 1.2551, that’s a 1-pip move, or a move from 1.2550 to 1.2555 is a 5-pip move. As you will see, the pip is the final decimal point.

Both currency pairs have four decimal points – the Japanese yen is the unique one out. Pairs that contain JPY have just 2 decimal points (e.g., USD / JPY=86.51).

Lot

Forex is traded in quantities called lots. One standard lot > has 100,000 base currency units, while a micro lot has 1,000 units.

For instance, if you buy 1 standard lot of EUR / USD at 1.325, you buy 100,000 Euros and sell 131,250 US Dollars. Also, when you sell 1 micro lot of EUR / USD at 1.3121, you sell 1,000 Euros, and you buy 1,313. US dollars.

Pip Value 

The pip value indicates the value of 1 pip. The pip value adjusts according to market fluctuations. So it’s essential to keep an eye on the currency pair(s) you’re trading and how the market behaves.

Now let’s talk about what you’ve heard about the pips! To take advantage of the pips and see a substantial increase/decrease in profit, you would need to trade significant amounts. Suppose that your account currency is USD, and you want to exchange 1 standard lot of USD / JPY. How much is 1 pip worth per $100,000 USD / JPY currency pair?

The formula for the estimation is as follows:

Amount x 1 pip = 100,000 x 0.01 JPY = JPY 1,000 If USD / JPY = 130.46, then JPY 1,000 = USD 1,000/130.46 = USD 7.7 Hence, the value of 1 pip in USDJPY is equal to: (1 pip, with correct decimal positioning x amount / exchange rate)

Here’s another example of this:

In the EUR / USD set, the difference between 1.3151 and 1.3152 is 1 pip, so 1 pip is 0.0001 USD. How much US dollar is the worth of this $1,000 micro-batch movement? $1,000 x $0.0001 USD = $1 USD.

Leverage 

Strictly speaking, via leverage, the Forex broker lends you funds so that you can exchange larger lots:

Leverage depends on the broker and its versatility. Around the same time, the leverage varies: it can be 100:1, 200:1, or even 500:1. Note that with leverage, you can use $1,000 to trade $10,000 ($1,000×100) or $500,000 ($1,000×500) or $200,000 ($1,000×200).

That sounds fantastic, but how does it work? I open a trading account with a broker, and I get a loan from my broker as easy as that?

First, it depends on what type of account you run, what the leverage for that specific type of account is, and how much leverage you want. Don’t be selfish, but be too shy, neither. Leverage can be used to optimize profits – but even costs, if you’re too greedy.

Secondly, the broker may require an initial margin on the account, i.e., a minimum deposit.

How does this work?

You launch a trading account with a balance of 1:100. You want to sell a $500,000 spot, but you just have $5,000 in your wallet. Don’t worry; the lender will lend you the additional $495,000 and put aside $5,000 as the good faith deposit.

The income you earn from investing will be credited to the balance of your account – so if there are expenses, they will be deducted. Leverage increases your purchasing power and will increase your profits and your losses.

Only select a broker that provides no negative balance cover, so your risks will never outweigh your cash. It means that if your loss is USD 5,000, your accounts will be immediately closed so that you don’t end up costing your broker money.

Equity

It is the cumulative sum of money in your trading account, including your income and loss. For instance, if you have invested USD 10,000 into your account and you have now made a profit of USD 4,000, your equity is USD 14,000.

Used Margin

It’s the sum of money the broker sets back so that the new trading accounts can be left open, so you don’t end up with a negative balance.

Free Margin

It’s the sum of money in your brokerage account so you can set up new trading positions.

Free Margin = Equity – Used Margin.

This implies that if your equity is USD 13,000 and your available positions need USD 2,000 margin (used Margin), you will be left with USD 11,000 (free margin) to open new positions.

Call Margin

Call Margin is a significant aspect of risk management: as long as your Equity declines to a percentage of the Margin used, the forex broker will tell you that you need to invest more money if you wish to maintain the spot.

Execution

It’s the process of executing an order. When you put an order, it will be sent to your broker, who determines whether to fill it out, deny it, or re-quote it. After you have concluded your order, you will receive an email from your broker. Like other forex traders, brokers work with a stringent policy of No Rejections and No Re-quotes.

The instructions must be followed quickly. When your order is overdue, it will cause you to fail. That’s why your forex broker should be able to conduct orders in less than 1 second. Why? Forex is a fast-moving market – and often forex brokers don’t keep up with its tempo, or deliberately slow down execution to snatch a few pips from you even during sluggish market movements.

Re-quote 

A re-quote is an unequal form of execution used by some traders. It happens when the broker doesn’t want to execute the order at the price you entered, so slows down the implementation for its profit.

  • How is this going to take place?
  • You agree to buy or sell a currency pair at particular market value;
  • Click the button to place your order;
  • Your broker shall receive the order;
  • You will get a re-quote prompt on the trading forum you are using;
  • You may either cancel your order or accept a lower price.
  • How are you going to stop re-quotes?
  • Select a forex broker with no re-quote policy;
  • Place a limit order: notify your broker in advance that you are only available to order at a specific price or better.

Now you’ve taken your first baby moves and learned to mess around in the forex world. Perhaps notably, you should learn the simple forex terms. It’s time to launch a demo account and start practicing virtual assets. Though, before you do so, you have to make two crucial decisions: you have to pick a broker and a trading site.

Stop-entry Order 

This is an order you give to buy above the current price or sell order below the current price because you believe the market would stay in the same direction. It’s the inverse of a limit order.

Suppose the EUR / USD is priced at 1.34. You want to go for a buy (i.e., put a buy order on this currency pair) if the price is 1.36, then you place a stop order to buy at 1.36. This command is referred to as a stop-entry signal.

Take Profit Order (TP)

It is an order that shuts your trade as long as it has achieved a certain level of profit.

Stop-Loss Orders (SL)

It’s an instruction to stop the trade as soon as it reaches a certain point of loss. Through this approach, you can reduce your risk and prevent wasting any of your money.

Market Order / Order of Entry

It is an offer to purchase or sell the currency at the current rate.

Open Order

This is an order to buy/sell a financial asset (e.g., Forex, bonds, or goods such as oil, gold, silver, etc.) that must stay open until you close it, or you let your broker shut it down for you (e.g., through telephone trading).

Limit Order

It is an order placed apart from the current market value.

Assuming the EUR / USD is being traded at 1.34. You want to go short (place a selling order on this currency pair) because the price is 1.36, then you put an order for the price of 1.36. This instruction is considered a limit order. Therefore the order should be placed until the price hits the mark of 1.35. The buy limit order is always set below the current rate, while the selling limit order is always placed above the current price.

Long position

Once you enter a long position, you’re buying a base currency.

Suppose you pick a pair of EUR / USD. You expect the EUR to rise relative to the USD, and you can buy the EUR and make a profit from its gain in value.

Short position

Once you reach a short position, you’re selling a base currency. If you chose the EUR / USD pair again, except this time you expect the EUR to fall relative to the USD, you can sell the EUR and make a profit from its decrease in value.

Close Trade 

When you reach a long (buying) position and the base currency rate has increased, you want to make a return. You have to close the place to do so.

 


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