Educational

Forex Definition and Basic Terms

What is Forex?

Forex, more commonly known as foreign exchange, FX or currency trading, is a worldwide decentralized market or over-the-counter (OTC) market for the trading of currencies. This market controls the foreign exchange rate.

Forex word in a dictionary. Foreign exchange concept

The foreign exchange market is the “place” where currencies are trading. Currencies are significant to most people around the world, whether they realize it or not, because currencies need to exchange in order to conduct foreign trade and business.

As the largest market in the world by far, bigger than the stock market or any other, with an average daily trading volume exceeding $5 trillion, there is high liquidity in the forex market.

The Forex Market

The foreign exchange market works through financial institutions, and operates on several levels. There are actually three ways that institutions, corporations, and individuals trade forex: the spot market, the forwards market, and the futures market.

What is the spot market?

The spot market is also called the cash market or the physical market, which is a financial market in which financial instruments or commodities are traded for immediate delivery.

Delivery is the exchange of cash for the financial instruments. In spot markets, spot trades made with spot prices.

Spot prices

Is the current price in the marketplace at which a given asset – such as a security, commodity, or currency – can be bought or sold at a particular time at a specified place (like an exchange). It contrasts with a futures market, in which delivery is due at a later date.

Forward market

Is the informal over-the-counter financial market that sets the price of a financial instrument or assets for future delivery.

Futures exchange or futures market

Is a centralized financial exchange for buyers and sellers from around the world who meet and enter into standardized future contracts.

In the FX markets, instead of goods, there are different types of currency trades with the majority of trades involving the US dollar. In fact, almost a quarter of all currency transactions that take place are traders exchanging euros for US dollars and vice versa.

Note that you’ll see the terms: FX, forex, foreign-exchange market, and currency market. These terms are the same and all refer to the forex market.

 

The Basic Terms

Currency Pairs

currency pair is the quotation of the relative value of a currency unit against the unit of another currency in the foreign exchange market.

The first listed currency of a currency pair is the counter currency, and the second is the quote currency and the currency that quoted in relation is the base currency or transaction currency.

Counter currency

Is the currency use as the reference or second currency in a currency pair.

Quote currency

Is the second currency quote in a currency pair in forex. In a direct quote, the quote currency is the foreign currency. In an indirect quote, the quote currency is the domestic currency.

Direct quote

Is a foreign exchange rate involving a quote in fixed units of foreign currency against variable amounts of the domestic currency.

Indirect quote

Is a currency quotation in the foreign exchange market that expresses the amount of foreign currency required to buy or sell one unit of the domestic currency. An indirect quote is also known as a “quantity quotation”.

Quote currency is often referring  as the “secondary currency” or “counter currency.”

Exchange Rate

In finance, exchange rate is the price of one currency in terms of another currency. It is regarding the value of one country’s currency in relation to another currency.

The exchange rate may change in 2 days or 1 week, though. It may even stabilize for a while.

However, exchange rates can also be quoted against another nation’s currency, which is known as a cross currency, or cross rate.

Cross rate

Is the currency exchange rate between two currencies when neither are the official currencies of the country in which the exchange rate quote is given.

Quote

A quote is the last price at which a security or commodity traded, meaning the most latest price to which a buyer and seller approved and at which some amount of the asset was transacted.

The bid or ask quotes are the most present prices and amounts at which the shares can be bought or sold. This is also known as an asset’s “quoted price.”

Ask

Is the price a seller is willing to accept for a security, which is often refer to as the offer price.

Bid

Is the price a buyer is willing to pay for a security, and the ask will always be higher than the bid.

Current price

Is the actual selling price of a security trading on an exchange, as well as the latest price of a security listed in an investment portfolio.

Spread

A spread is the difference in pips between the bid and the ask price of a security or asset. It can also refer to an options position established by purchasing one option and selling. It is another option of the same class but of a different series.

The spread represents the brokerage service costs and replaces transaction fees.

Account Currency

It is the currency you choose when you open a trading account. All your profits and losses will converted into that particular currency.

Accounting currency is the financial unit, it use when recording transactions in a company’s books. It is also the reporting currency. Often, the accounting currency is in the same currency denomination as the local currency where the company operates.

Pip

A pip, an acronym for “price interest point”, is a tool of measurement related to the smallest price movement made by any exchange. Since most major currency pairs are priced to four decimal places, the smallest change is that of the last decimal point; for most pairs, this is the equivalent of 1/100 of 1%, or one basis point.

Trade word in a dictionary. Trade close up photo.

Basis Points (BPS)

Refers to a common unit of measure for interest rates and other percentages in finance.

Fractional Pip

Fractional pips, also known as ‘pipettes’, refer to the fifth decimal place seen in some Forex price quotes. It is an extra decimal place in the exchange rate.

Pip Value

The pip value shows how much 1 pip is worth. The pip value changes in parallel with market movements. So it is good to keep an eye on the currency pair(s) you are trading and how the market changes.

Margin

It is the difference between the total value of securities hold in an investor’s account and the loan amount from a broker
 
Margin is the minimum amount of funds, express the percentage that you will need if you want to open a position and keep your positions open.

Leverage

It results from using borrowed capital as a funding source when investing to expand the firm’s asset base and generate returns on risk capital.

Leverage an investment strategy of using borrowed money — specifically, the use of various financial instruments or borrowed capital — to increase the potential return of an investment.

Equity

When studying financial statements, an important concept is the balance sheet identity.  It states that assets minus liabilities equal stockholders’ equity.

It is the total amount of money in your trading account, including your profit and losses.

See also: Forex Trading: the Currencies, the Good, and the Bad

Margin Call

A margin call happens when a broker demands that an investor deposits additional money or securities so that the margin account was purchased up to the minimum maintenance margin.

It is also a notification you will receive when there are not enough funds in your trading account to support open trades.

Hedging

Not all futures trading are about moving goods to market. Hedging, or entering into a transaction in order to reduce existing exposure to price fluctuations, is also a major component of trading volume.

Commissions

A commission is a service charge assess by a broker or investment advisor in return for providing investment advice and/or handling the purchase or sale of a security.

Service charge is a type of fee collected to pay for services related to the primary product or service being purchased.

Volume

Volume is the number of shares or contracts traded in a security or an entire market during a given period of time. For every purchaser, there is a seller, and each transaction contributes to the count of total volume.

In general, a seller is an individual or entity who exchanges any good or service in return for payment.

Slippage

When you’re trading, sometimes you’ll notice a small difference between the price you expect and the execution price (when the trade has executed the price).

Slippage is the difference between where the computer signaled the entry and exit for a trade. And where actual clients, with actual money, entered and exited the market using the computer’s signals.

It often occurs during times of higher volatility when market orders used, and also when big orders executed when there may not be enough interest at the wanted price level to maintain the expected price of trade.

Volatility

Is a statistical measure of the dispersion of returns for a given security or market index.

Position

It is a trade that you hold open during a certain period of time.

A position is the amount of a security, commodity, or currency which is own by an individual, dealer, institution, or other fiscal entityThey come in two types: short positions and long positions.

Short position

Is selling first and then buying later.

Long position

Is the buying of a security such as a stock, commodity, or currency with the expectation that the asset will rise in value.

See also: Buying and Selling Shares 101: A Beginner’s Guide

Re-quote

A re-quote in the Forex world means that the broker you are dealing with is not able or willing to give you a trade based upon the price you entered.

It occurs when your broker doesn’t want to execute your order on the price you entered. And it slows down execution for its own benefit.

Conclusion

Even though foreign exchange may be confusing, in today’s worldwide marketplace. There is a critical need for almost everyone to understand foreign exchange like never before.

As the world shrinks, there is an ever-increasing chance that we will require to address the risks associated with the fact that there are different currencies used all around the world and that these currencies will have an immediate effect on our world.

HQBroker is here to give you a daily news roundup about the forex, commodities, technologies, automobiles, and economies. You can open an account now and make yourself updated with essential news in the market. Share your thoughts and experiences with us by commenting your HQBroker reviews.

 

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