If you are looking to become an investor in the foreign exchange market — also known as the Forex market — there are three types of accounts designed for retail investors: standard lot, mini lots and micro lots. Best of all, beginners can get started with a micro account for as little as $50.
However, before you begin your Forex market, take some time to learn a little more about how foreign currency trading works by reviewing some of the most important terms of the Forex market. If you already have some experience trading stocks or options, you should pick up Forex trading very easily.
Here are some of the most common — and important to know — Forex terms.
BASE CURRENCY: The first currency quoted in a currency pair on Forex. For example, for the currency pair USD/GBP, the U.S. Dollar is the base currency. The base currency is also known as the domestic currency or accounting currency.
CROSS CURRENCY PAIR: A pair of currencies traded in Forex that does not include the U.S. dollar. An example of a cross currency pair would be NZD/GBP (the New Zealand Dollar/Great British Pound). When trading these cross currency pair, one currency is traded for another without having to first exchange the currencies into U.S. dollars.
CURRENCY PAIR: The quotation and pricing structure of the currencies traded in the Forex market, in which the value of a currency is determined by its comparison to another currency. These currency pairs are usually written like this: AUD/USD. The first currency of a currency pair is called the “base currency” (in our example, the Australian dollar), and the second currency is called the “quote currency” (the U.S. dollar in this example). The currency pair indicates how much of the quote currency is needed to purchase one unit of the base currency. (At the time of this article, the AUD/USD = .76, meaning one Australian Dollar is worth 76 U.S. cents.)
PIP: A pip is the smallest price change that a given exchange rate can make. Since most major currency pairs are priced to four decimal places (that is, .0001), the smallest change is that of the last decimal point. A common exception is for Japanese yen (JPY) pairs which are quoted to the second decimal point (.01).
QUOTE CURRENCY: As seen above, the second currency quoted in a currency pair in Forex is known as the quote currency. In a direct quote, the quote currency is the foreign currency. In an indirect quote, the quote currency is the domestic currency. This is also known as the “secondary currency” or “counter currency”.
Now that we’ve reviewed basic terminology, let’s look at some of the differences between trading stocks vs. currencies. In currency trading you are always comparing one currency to another so Forex is always quoted in pairs. Whenever you see a trader only talk about one currency — such as saying the euro (EUR) is trading at 1.3224, you may assume that the unsaid currency is the U.S. dollar (USD).
When looking at the quote screen for the first time it may seem confusing at first, however, it’s actually very straightforward. Below is an example of a EUR/USD quote:
EUR/USD = 1.1141
The quote example shows traders how much one euro is worth in US dollars. The “base currency” here is EUR, and the “quote currency” is USD.
When traders buy or sell a currency pair, the action is performed on the base currency.
If a trader is bearish on euros, he could sell EUR/USD. When the pair EUR/USD is sold, the trader is not just selling euros but also buying US dollars simultaneously, which makes up the pair trade.
Let’s say that you sold the EUR/USD at 1.1141. If the EUR/USD falls from that value, we know that the euro is getting weaker and the U.S. dollar is getting stronger. You might have also noticed the quote price has four places to the right of the decimal. Currencies are quoted in pips, where a pip is the unit you use to count your profit or loss. For pairs except for ones including the Japanese Yen (JPY), the fourth spot after the decimal point (at one 100th of a cent) is typically what traders watch to count “pips”.
Every point that place in the quote moves is 1 pip of movement. For example, if the EUR/USD rises from 1.1141 to 1.1146, the EUR/USD has risen 5 pips.
There’s a lot to learn about Forex trading, and we’ll provide more information for you right here in future articles…