Basic Forex Terms You Should Know Before Trading
Trading currencies on the foreign exchange (forex) market can seem like entering a foreign land, with its language and customs. Before you start trading forex, it's essential to learn the basic forex terms and concepts that forex traders use daily. This knowledge will allow you to navigate the forex landscape confidently and communicate effectively.
In forex, you’ll encounter unique terms like:
“pip,”
“leverage,”
“currency pairs,”
“bid price,”
“bear market,”
“base currency.”
You’ll need to understand key trading terms like spreads, margins, and position sizing. While forex terminology may seem convoluted initially, grasping these fundamental terms and ideas is critical for any beginning forex trader.
This article will explain some of the most common forex words and phrases. We’ll define terms like “open position,” “base currency,” and “going long or short.” You’ll also learn about different order types, including stop losses and take profits. By becoming familiar with basic forex vocabulary, you'll have an easier time developing trading strategies and analyzing the forex market.
With some study, you can learn the language of forex trading. This terminology precisely describes the instruments, players, and mechanics that make up the foreign exchange market. Fluency in forex terms will allow you to research trading techniques, evaluate signals and trends, and make informed trading decisions.
Start building your forex vocabulary today.
Basic Forex Terms
Exchange Rate
One of the most basic forex terminology is the exchange rate, which refers to the current market price at which one currency can be exchanged for another. It is essentially the price you pay to convert one currency into another and it tells you how much of one currency you need to buy one unit of another currency. The exchange rate is also sometimes called the foreign exchange rate or FX rate.
For instance, if the EUR USD exchange rate is 1.2500, then 125 USD is worth 100 EUR.
As of today, February 3, 2024:
1 US dollar is equal to about 0.93 euros.
1 US dollar is equal to about 1.34 Canadian dollars.
1 US dollar is equal to about 146.76 Japanese yen.
Exchange rates can fluctuate throughout the day based on various factors, including:
Supply and demand: If there is more demand for a currency than there is supply, the price of that currency will go up.
Interest rates: Countries with higher interest rates tend to have stronger currencies.
Economic performance: A country's economic performance can also impact its currency's value.
Political stability: Political instability can lead to currency devaluation.
Ask Price
The Ask Price, also known as the Offer Price, refers to the lowest price at which a seller is willing to sell a particular currency pair, or any other tradable security. It represents the minimum amount they are ready to accept in exchange for selling their holding.
Essentially, it's the price you would pay to buy the base currency in the pair.
Example:
Imagine you want to buy 100 Euros with US Dollars.
The current EUR USD Ask Price is 1.2000.
This means you would need to pay $120 to buy the 100 Euros.
The Ask Price is always slightly higher than the Bid Price, creating the bid-ask spread, which represents the dealer's profit.
Asset classes definition
In finance, an asset class refers to a category of financial instruments that exhibit similar characteristics and behave similarly in the marketplace. The 5 main asset classes are:
Equities
Fixed income
Commodities
Currencies
Real estate
These broad asset classes are traded in their respective financial markets, such as the stock market, bond market, forex market, futures market, and real estate market. Each market has its dynamics and offers different risk-return profiles. Diversification across different asset classes can help mitigate portfolio risk.
Currencies are a distinct asset class in the forex market with major currency pairs like EUR/USD and USD/JPY behaving differently than stocks and bonds.
Bid Price
The Bid price in forex, also known as the buying price, is the highest price a dealer is willing to pay for a specific currency in a currency pair. It represents how much of the quoted currency a trader will get for selling one unit of the base currency.
Here's how it works:
Currency Pair: A combination of two currencies, like EUR/USD (Euro versus US Dollar), GBP/JPY (British Pound versus Japanese Yen), etc.
Base Currency: The first currency listed in the pair (EUR in EUR/USD).
Quote Currency: The second currency listed in the pair (USD in EUR/USD).
Example:
Imagine you have 100 Euros and want to exchange them for US Dollars. The current EUR/USD Bid Price is 1.1900 which means you would receive $119 for selling your 100 Euros.
Base rate definition
The base rate is the benchmark interest rate set by a central bank, such as the Federal Reserve in the United States or the European Central Bank in Europe. This rate influences the interest rates that banks charge borrowers and offer to lenders.
By adjusting the base rate, central banks can try to control inflation and stimulate economic growth. A higher base rate makes borrowing more expensive and generally strengthens the country's currency by attracting foreign capital flows seeking higher returns.
The base rate goes by different names depending on the country, such as:
"Official Cash Rate" in New Zealand
or the "Federal Funds Rate" in the US.
Currency Pairs
In the world of finance, a currency pair is a quotation of two different currencies, representing their relative value to each other. It's essentially a price tag indicating how much of one currency you need to exchange to get one unit of the other.
Think of it like this: imagine you're at a currency exchange booth and want to convert your US dollars (USD) to Euros (EUR). The currency pair you'll encounter will look something like this: EUR/USD.
EUR is the base currency, which means it's the reference point for the quotation.
USD is the quote currency, indicating how many US dollars you need to exchange for one Euro.
So, if the exchange rate for EUR/USD is 1.2000, it means you'll need to pay $1.20 for every €1 you want to buy.
There are many different currency pairs available, with the most traded ones involving major currencies like the US dollar, Euro, Japanese Yen, British Pound, Australian dollar, and Swiss Franc.
Here are some additional details about currency pairs:
Major currency pairs: These are the most heavily traded pairs, typically involving the US dollar against other major currencies. Examples include EUR/USD, USD/JPY, GBP/USD, USD/CHF, and AUD/USD.
Minor currency pairs: These pairs involve less-traded currencies, often paired with a major currency. Examples include EUR/GBP, AUD/NZD, and USD/MXN.
Exotic currency pairs: These pairs involve currencies from emerging markets or less frequently traded economies. They tend to be more volatile than major or minor pairs.
Short Position
A short position in forex trading is also known as shorting or going short, it refers to selling a currency pair with the expectation that it will fall in value, allowing the trader to buy it back at a lower price and make a profit on the difference.
To open a short position, traders click the "Sell" button on their trading platform, which immediately opens a short trade at the current market price.
Example:
Let's say you think the Euro (EUR) will weaken against the US Dollar (USD). You short the EUR/USD pair at 1.1200, meaning you borrow 1 EUR and sell it for 1.12 USD. Later, if the EUR/USD drops to 1.1100, you buy back 1 EUR for 1.11 USD and return it to your broker. Your profit is 0.01 USD (or 10 pips).
Closing price definition
The closing price in forex trading refers to the final rate at which a currency pair traded at the end of the trading day or trading session. In the foreign exchange market, which operates 24/5 due to trading happening across different time zones, the concept of a single, global "closing price" doesn't directly translate.
However, the 5:00 PM EST which is also when the New York trading session ends, is regarded as the standard close price in the foreign exchange market.
Pip Value
In forex trading, a pip (percentage in point) represents the smallest price movement for a currency pair, which helps measure profit, loss, and risk across different trades.
Concept:
A pip usually equates to the fourth decimal place of a forex quote. For example, in EUR/USD 1.1234, one pip is 0.0001 (the "4" in the final decimal).
However, for JPY pairs, the pip is the second decimal place due to their lower individual value (e.g., USD/JPY 134.56 has a pip of 0.01).
Pip value varies depending on the currency pair:
For pairs with the USD as the quote currency, the pip value in USD remains constant for a specific lot size (e.g., 1 pip = $10 for a 100k lot).
For other pairs, the pip value in USD changes based on the exchange rate.
Calculating Pip Value:
Formula: Pip value in USD = (1 pip / quote currency price) * lot size
Example: Calculate the pip value in USD for 1 EUR/USD at 1.1234 with a 10k lot:
Pip value = (0.0001 / 1.1234) * 10,000 = $0.8906
Leverage
Forex leverage is a facility provided by forex brokers that allows traders to trade larger positions than their actual account balance. Leverage allows traders to multiply their buying power in the market by borrowing capital from their broker.
This is expressed as a ratio, like 10:1, 50:1, or even higher. A 10:1 leverage means you can control $10 for every $1 you deposit, but you need to provide a margin, which is a percentage of the total position value, as collateral.
Example:
With $1,000 and 10:1 leverage, you can open a $10,000 position.
If the currency pair increases 1%, your profit is $100 (1% of $10,000), essentially a 10% return on your $1,000 capital.
Used Margin
In forex trading, used margin represents the portion of your account funds currently tied up in open positions. It's essentially the collateral you've deposited to maintain your positions, calculated as the sum of all required margins for each open trade.
Example:
Imagine you open a EUR/USD position with a $10,000 value and a 1% margin requirement. This means you need $100 (1% of $10,000) as the required margin.
If you then open another USD/JPY trade with a $5,000 value and a 2% margin requirement, another $100 is used as a margin.
Your used margin becomes $200 ($100 + $100), reflecting the total capital locked in these open positions.
Day order definition
In forex trading, a day order refers to an instruction you give your broker to buy or sell a currency pair at a specific price, but with a crucial limitation: it only remains valid until the end of the trading day.
Example:
You think the EUR/USD will rise and place a day order to buy at 1.1300 (a limit order).
If the price reaches 1.1300 during the trading day, your order is filled and you buy EUR/USD.
But if the price stays below 1.1300 until the market closes, your order is canceled, and you miss the trade.
Long Position
In forex trading, a long position essentially means buying a currency pair with the expectation that its value will increase in the future. This allows you to potentially profit by selling the currency pair later at a higher price.
Example:
You believe the Euro will strengthen against the Dollar, so you open a long position on EUR/USD at 1.1200.
This means you buy 1 EUR for 1.1200 USD.
Later, if the EUR/USD pair rises to 1.1350, you sell your 1 EUR for 1.1350 USD, making a profit of 150 pips.
Limit Order
In forex trading, a limit order instructs your broker to buy or sell a currency pair at a specific price or better. This type of order offers more control over your trade execution compared to market orders.
You specify a limit price, which is the maximum price you're willing to pay for a buy order or the minimum price you'll accept for a sell order:
Buy limit order: The order is only executed if the market price falls to or below your limit price.
Sell limit order: The order is only executed if the market price rises to or above your limit price.
Futures contract definition
A futures contract is a standardized agreement between two parties to buy or sell a specific amount of a currency pair at a predetermined price on a specific future date. Unlike spot forex trades where currencies are exchanged immediately, futures contracts lock in the exchange rate and settlement date in advance.
Here's a breakdown:
You agree to buy or sell a particular currency pair at a fixed price (the delivery price) on a specific future date (the delivery date).
Both parties are legally obligated to fulfill the contract on the delivery date, regardless of the current market price.
This allows you to hedge against future price fluctuations or speculate on currency movements.
Interest rates definition
Interest rates represent the cost of borrowing a currency and are set by central banks to manage inflation and economic growth. Here's how they impact forex:
Higher interest rates in a country typically make its currency more attractive to investors seeking higher returns. This increased demand can lead to currency appreciation.
Conversely, lower interest rates make a currency less attractive, potentially leading to depreciation.
Therefore, comparative interest rates between different countries significantly influence foreign exchange movements.
Traders may borrow from a low-interest currency and invest in a high-interest one, pocketing the interest rate differential – this is known as the carry trade trading strategy.
Market order definition
A market order in forex trading instructs your broker to buy or sell a currency pair at the best available price currently quoted in the market. This means you essentially prioritize immediate execution over specific pricing, ensuring your trade happens as soon as possible.
Example:
You see the EUR/USD price quoted at 1.1234/1.1238 (bid/ask). You place a market order to buy 10,000 EUR.
Your broker might execute the order at different prices depending on available market liquidity:
If someone is selling 10,000 EUR at the ask price (1.1238), your order is filled at that price.
If several sellers offer smaller amounts, your order might be partially filled at different prices within the bid/ask range.
Stop-entry Order
In forex trading, a stop-entry order acts as an automated trigger to initiate a buy or sell trade only when the market price reaches a specific level you set. This allows you to automatically enter positions when your forecasted price movements occur, potentially capturing profitable opportunities.
Example:
You believe the EUR/USD will rise and want to buy at 1.1300. You set a buy-stop-entry order at 1.1300.
If the price reaches 1.1300, your order triggers and converts to a market order, buying EUR/USD at the prevailing market price (which could be slightly above or below 1.1300).
Close a Position
In forex trading, closing a position refers to ending your involvement in a trade you previously opened. Basically, you're undoing the initial buy or sell trade to get out of the market by doing the opposite trade to exit your previous trade:
For a long position, you sell the same amount of currency you bought to exit the trade.
For a short position, you buy back the same amount of currency you sold to close the trade.
Example:
You buy 10,000 EUR/USD at 1.1200 (long position).
Later, you decide to close the position. You sell 10,000 EUR/USD at 1.1300.
If the price increases, you have a profit (100 pips = 10,000 x (1.1300 - 1.1200)).
If the price decreases, you have a loss.
Exchange definition
In finance, an "exchange" is a marketplace where investors and traders buy and sell financial instruments like stocks, bonds, currencies, commodities, and derivatives, providing a platform for buyers and sellers to come together to trade financial instruments in a fair, orderly, and efficiently.
Examples include the New York Stock Exchange (NYSE) for stocks, the Chicago Mercantile Exchange (CME) for futures contracts, and the Coinbase or Binance for cryptocurrencies.
Take Profit Order (TP)
A Take Profit Order is a type of limit order you place with your broker to automatically close a position when the market price reaches a specific profit level. This helps you lock in profits and avoid leaving your trade open to potential losses if the market turns against you:
For long positions: Placed above the entry price, the order triggers when the price hits or crosses your specified profit level.
For short positions: Placed below the entry price, the order triggers when the price falls to or below your specified profit level.
Open Positions Definition
An open position refers to any trade you've initiated but haven't yet closed in the forex market. This means you're currently holding either a long or short position in a currency pair.
Fundamental analysis definition
Fundamental analysis (FA) in forex trading involves assessing the economic, political, and social factors that can influence the intrinsic value of a currency and, consequently, its exchange rate. It essentially helps you understand the "why" behind currency movements, going beyond just technical chart analysis.
High-frequency trading definition
High-frequency trading (HFT) refers to algorithmic trading strategies that involve rapidly executing a large number of orders and positions to capitalize on small price movements in the forex market.
Resistance level definition
A resistance level is a specific price at which selling pressure is strong enough that it prevents the price of a currency pair from moving higher. It indicates a ceiling level where the increased supply of the currency pair meets the corresponding demand.
Key psychological price points like the big round number 1.3000, prior swing high, Fibonacci levels, or moving averages often act as resistance. Resistance levels are marked horizontally on charts.
Working order definition
Working orders refer to open market orders that have been placed but not yet executed. These working orders are pending in the market waiting to be triggered.
The main types of working orders are:
Buy limit - An order to buy the currency pair at a specified lower price. It is placed below the current market price.
Sell limit - An order to sell the pair at a specified higher price. It is placed above the current market price.
Buy stop - A buy trade order above the current market price. It is triggered if the price rises to the specified level.
Sell stop - An order to sell below the current market price. It is triggered if the price falls to the specified level.
Short selling definition
Short selling involves selling a currency pair first with the expectation of repurchasing it later at a lower price. It allows traders to profit from declines in the currency exchange rates.
Bull Market/Bear Market
Bull Market represents a sustained period of rising prices or an upward trend in a forex pair or the overall forex market. The bear market represents a sustained period of falling prices in a currency pair or the overall forex market.
Margin Call
A margin call in forex trading is a demand from your broker to deposit additional funds into your account when the value of your open positions falls below a certain level. This level is called the maintenance margin, which is typically expressed as a percentage of the total value of your positions.
Demo account
A demo account, also known as a practice account, is a simulated trading environment provided by forex brokers. It allows you to trade with virtual currency to practice trading strategies, learn the platform, and gain experience before risking real money.
Final Thoughts
While this article covers fundamental forex terms like exchange rates, currency pairs, base currencies, and going long or short, it's just the beginning. As you gain experience, you'll encounter many more terms for strategies, order types, risk management techniques, and chart analysis. Don't be intimidated by the trading terms lingo - add new words to your trading dictionary as you progress.
The most successful forex traders never stop deepening their knowledge so continue reading articles, forums, glossaries, and guides.
Don't be afraid to ask questions either - no term is too basic.
When in doubt, refer back to this primer on key forex language. With consistent learning over time, you too will be fluent in discussing pips, lots, volatility, margins, and all aspects of forex trading.
With the foundation of basic forex terminology, you can now start researching brokers to find the right platform for you. Comparing brokers can be overwhelming though - how do you evaluate factors like regulation, trading tools, asset classes, and commissions?
Rather than tackle broker research alone, leverage the analysis on our forex broker comparison page.
