Lesson 15 – Forex Terminology, A Guide
When you start trading, you’ll definitely start to encounter a lot of terms and jargon that you won’t fully understand yet. Don’t panic, this happens to everyone.
But, it’s important that you understand these terms to you actually get what’s going on in your screen.
In this lesson, we will go over key terms that you will need to understand before you start forex trading.
Bid and ask
When you see currency pairs on the market, you will always see two displayed exchange rates at any point in time. These two are the bid price and ask price.
The bid – is the highest price someone is willing to pay for that currency.
The ask (sometimes called the offer price) – is the lowest price that someone is willing to sell that currency for.
The bid price is always set low than the ask price since buyers are trying to get the best price for their trade. It’s in the middle of these two prices when they meet, that transactions happen.
Simply put, the spread is the difference between the bid and ask prices, and is typically measured in pips.
It’s also used as an indicator to judge the liquidity of the market. If the spread is smaller, it means the market is more liquid, and vice versa.
For example, the spread seen on major currency pairs like EUR/USD is usually very low because of the liquidity caused by the high trading volume, whereas a low volume exotic or cryptocurrency pair will have a much higher spread.
When times are uncertain and highly volatile, the spread often increases.
This makes it more expensive for traders to enter a position and less likely for them to turn a profit in each trade as the spread widens.
When using brokerages, the spread is usually how they make their profit (assuming they charge no commissions elsewhere).
Example of a bid/ask spread:
IMAGE SHOWING A BID ASK SPREAD
Looking at this, we can calculate the spread by subtracting the bid price from the ask price.
Spread = 14523 pips – 14520 = 3 pips
Due to high competition, brokers have to compete by offering low spreads as one of their main selling points to customers.
This is why they introduced the 5th decimal point (pipettes) we mentioned before in a previous lesson, so that they can compete on even smaller spreads. Which is good for us.
EXAMPLE SHOWING BID ASK OF 5 DECIMAL POITNS
Spread = 13443.3 pips – 13443.8 = 0.5 pips
Slippage is what happens when you place an order at one price, but the trade is executed at a different price.
This usually happens due to slow execution speeds and highly volatile prices that move up and down a lot.
This is very normal to happen to every trader so there’s no need to worry if this happens to you. Sometimes slippage will work to your advantage and give you a better price than you originally placed for, but other times it will work the other way.
If you trade with major currency pairs with high volume and liquidity, then slippage should be too much a problem.
Margin is pretty much the amount you need in a trading account to be able to access leverage. Often people treat margin like it is collateral or a deposit for you to access a loan.
You need a margin account to access leverage, which isn;t the same as a standard brokerage account, but most of the time, the trading accounts you encounter in forex trading platforms are margin accounts.
But this is something worth checking when you do your research before you set up an account with someone.
When you trade with a margin account, the word “margin” is used to describe the balance amount that you have in the account.
Using leverage, if you enter a £1,000 position with a 8:1 leverage.
£1,000/8 = £125
Here, your necessary margin would be £125. This means that you only need £125 in your account in order to place this trade.
It’s really important to also take note of what currency your account balance is kept in. Usually, it is the currency that you filled your account with at the start.
When you trade currency pairs that do not include your default account currency then you’ll have to exchange it to the base currency of the pair that you are trading, every time you trade that currency pair.
All profits/losses are converted and transferred back into your default currency. But, be aware, a lot of brokerages charge fees for currency conversion which will eat into your profits over time. So be aware of this when you consider trades that don’t involve your default currency, and who you choose as your brokerage.
In the next lesson, we’ll cover more about “Leverage for forex traders” and how it works.