Essential Forex TermsReading Time: 6 Min Experience Level:Beginner
Exchange rate: It refers to the value of one currency expressed in terms of another.
When we say GBP/USD = 1.38, we mean that 1 British Pound is worth 1.38 US Dollars.
You will always find two currencies in any exchange rate, and the number that follows is always expressing how much one unit of the currency that is mentioned first, is worth of the second currency.
We call the currency mentioned first “base currency” and we call the currency mentioned second “quote” or “counter” currency.
Cross rate: It is the currency exchange rate of two currencies quoted in a country where they are not the official currencies. However, traders use this term to refer to currency quotes that connect two major currencies, where none of them is the US Dollar.
If we quote the exchange rate between the Euro and the Dollar in Japan, this would be considered a cross rate. In trading terminology, GBP/AUD is a cross rate, because it involves two major currencies, where none of them is the US Dollar.
Pip: It is a standardized unit that measures the change in value between two currencies. Originally, the majority of currency pairs were quoted to the fourth decimal point (the second decimal point for JPY pairs). A pip represents the last and smallest number in those four digits.
A GBP/USD quote is 1.3814, meaning that for one GBP, we can buy 1.3814 US Dollars. If this quote experienced a one-pip increase, the value of the GBP to the USD will be 1.3815.
In recent years, the concept of fractional pip was introduced. A fractional pip is one-tenth of a pip, which means it appears in the fifth decimal point (the third for JPY pairs). So, while in the past GBP/USD was quoted like the example above, now, you will find that it is quoted with one additional digit, for example, 1.38147.
Margin: It is the amount of money required to open or maintain a position in a trade. Margin can be divided into two parts; the free and the used.
Free margin is the amount available to open new positions.
Used margin is the amount being used to maintain an open position.
Used margin is deducted from free margin. For example, if a trader deposits USD 10,000 in a Forex account and opens a trade requiring a USD 2,500 margin to remain open, the USD 2,500 is then called “used margin”. This amount is now locked, meaning that the trader cannot use it to open other positions, until they close this trade.
Now, the available margin decreases from USD 10,000 to USD 7,500.
Another important concept is “margin level”.
To calculate the margin level, we use this equation:
Margin level = (Equity / Used margin) x 100%
In the example above, the margin level would be (USD 10,000 / USD 2,500) x 100% = 400%.
The higher the margin level is, the more cash is available for other trades. But, when the margin level drops to the 100% benchmark, it means that no more trades can be opened by the trader.
If the investor’s account equity falls below the minimum amount required to maintain an open position, they will receive a margin call from the broker requesting to either add more money or close some, or all, of the open positions.
Leverage: It is a facility that brokers provide, which allows traders to open positions that are bigger than the total account balance.
A leverage of 1:30 means that for every Dollar the trader deposits, they can trade 30 Dollars. Leverage is not the same between all brokers, as one broker may offer 1:30, another may offer 1:20. Leverage could also differ from one instrument to another, even when you are trading with the same broker. For example, a broker could offer leverage of 1:30 when you trade currencies, but only 1:20 when you are trading stocks.
Bid/ask prices: The bid price is what the dealer is willing to pay you for a currency. The ask price is the rate at which a dealer will sell the same currency.
Usually, the bid price is written first, or on the left of the pair, and the ask price on the right.
To make things as simple as possible, if you place a sell order, it will be executed at the bid price, and if you place a buy order, it will be executed at the ask price.
Spread: It is the difference between the bid and ask prices of a currency pair,
or in other words, buying and selling prices. This is known as a bid-ask spread.
If the EUR/USD prices are at 1.1600/03, the spread is the difference between 1.1600 and 1.1603, which is 3 pips.
Major Pairs and their Nicknames
Sometimes, you will be hearing nicknames that seem known, but you don’t understand. So, we gathered some of the most popular nicknames to familiarize you with the jargon.
- USD = Greenback or The Buck
- EUR = Single currency or Fiber
- USD/JPY = Gopher or Ninja
- GBP/USD = Cable
- USD/CHF = Swissy
- USD/CAD = Loonie or The Funds or Beaver
- AUD/USD = Aussie or Ozzie or Matie
- NZD/USD = Kiwi
- EUR/JPY = Euppy or Yuppy
- GBP/JPY = Geppy or Guppy
- EUR/GBP = Chunnel