Important Forex Trading Terms

• Spread

  The spread is the difference between the price that you can sell currency at (Bid) and the price you can buy currency at (Ask). The spread on majors is usually 3 pips under normal market conditions. For more information on the trading conditions at Saxo Bank, go to the Account Summary on your Client Station and open the section entitled “Trading Conditions” found in the top right-hand corner of the Account Summary.

• Pips

  A pip is the smallest unit by which a cross price quote changes. When trading Forex you will often hear that there is a 3-pip spread when you trade the majors. This spread is revealed when you compare the bid and the ask price, for example EURUSD is quoted at a bid price of 0.9875 and an ask price of 0.9878. The difference is USD 0.0003, which is equal to 3 “pips”.
  
  On a contract or position, the value of a pip can easily be calculated. You know that the EURUSD is quoted with four decimals, so all you have to do is cancel out the four zeros on the amount you trade and you will have the value of one pip. Thus, on a EURUSD 100,000 contract, one pip is USD 10. On a USDJPY 100,000 contract, one pip is equal to 1000 yen, because USDJPY is quoted with only two decimals.

Trading Scenario – Trading Rising Prices

If you believe that the euro will strengthen against the dollar you'll want to buy euro now and sell it back later at a higher price.

• You buy euro

We quote EURUSD at Bid 0.9875 and Ask 0.9878, which means that you can sell 1 euro for 0.9875 USD or buy 1 euro for 0.9878 USD. In this example you buy euro 100,000, at the quote price of 0.9878 (ask price) per euro.

• The market moves in your favor

Later the market turns in favour of the euro and the EURUSD is now quoted at Bid 0.9894 and Ask 0.9896.

• Now you sell your euro and get the profit

You sell euro at a Bid price of 0.9894.

• The profit is calculated as follows

Sell price-buy price x size of trade (0.9894 minus 0.9878) multiplied by 100.000 = USD 140 Profit (Note that the profit or loss is always expressed in the secondary currency)

Trading Scenario – Trading Falling Prices

If, on the other hand, you believe that the euro will weaken against the dollar, you'll want to sell EURUSD.

• You sell euro

We quote EURUSD at a Bid price of 0.9875 and Ask price of 0.9880 and you decide to sell euro 100,000 at a Bid price of 0.9875.

• The market moves in your favour

The euro weakens against the dollar and the EURUSD is now quoted at bid 0.9744 and ask 0.9749.

• Now you buy back your euro

You buy EUR at an ask price of 0.9749.

• Your profit/loss is then

Sell price-buy price x size of trade (0.9875 minus 0.9749) multiplied by 100.000 = USD 1260 Profit

Remember that trading EUR 100,000 as we have done in our examples, does not mean that you have to put up euro 100,000 yourself. On a 2% margin means that you have to deposit 2.0% of euro 100,000, which is euro 2,000 on margin as a guarantee for the future performance of your position.

Further Reading

To see how you can trade the Forex market and benefit from our toolbox of information and live quotes, please proceed to the Forex Quick Start found under the Trading menu of SaxoTrader.

Glossary

• Appreciation

An increase in the value of a currency.

• Ask

The price requested by the trader. This usually indicates the lowest price a seller will accept.

• Base currency

The currency that the investor buys or sells (i.e. EUR in EURUSD).

• Bear

Someone who believes prices are heading down. A bear market is one in which there has been a sustained fall in prices and which does not look like it will recover quickly.

• Bid

The price offered by the trader. This usually indicates the highest price a purchaser will pay.

• Bid/Ask

The Bid rate is the rate at which you can sell. The Ask (or offer) rate is the rate at which you can buy.

• Bull

Someone who is optimistic about the market. A bull market is characterised by enthusiastic and sustained buying.

• cross

When trading with currencies, the investor buys one currency with another. These two currencies form the cross: for example, EURUSD.

• Cross rate

An exchange rate that is calculated from two other exchange rates.

• Depreciation/decline

A fall in the value of a currency.

• Exchange rate

What one currency is worth in terms of another, for example the Australian dollar might be worth 58 US cents or 70 yen. Currencies traded freely on foreign-exchange markets have a spot rate (applying to trades settled “spot”, i.e., two working days hence) and a forward rate. Countries can determine their exchange rates in a variety of ways. 1. A floating exchange rate system where the currency finds its own level in the market. 2. A crawling or flexible peg system which is a combination of an officially fixed rate and frequent small adjustments which in theory work against a build-up of speculation about a revaluation or devaluation. 3. A fixed exchange-rate system where the value of the currency is set by the government and/or the central bank.

• EURUSD

Means that you trade EUR against dollars. If you buy euro you pay in dollars and if you sell euro you receive dollars.

• FX, Forex, Foreign Exchange

All names for the transaction of one currency for another, e.g. you buy GBP 100.00 with USD 150.25 or sell USD 150.25 for GBP 100.00.

• Interbank

Short-term (often overnight) borrowing and lending between banks, as distinct from a banks business with their corporate clients or other financial institutions.

• Interest rate differential

The yield spread between two otherwise comparable debt instruments denominated in different currencies.

• Leverage (gearing)

The investor only funds part of the amount traded.

• Long

To buy.

• Long position

A position that increases its value if market prices increase.

• Liquid (-ity)

The capacity to be converted easily and with minimum loss into cash. A liquid market is one in which there is enough activity to satisfy both buyers and sellers. Ultra-short-dated treasury notes are an example of a liquid investment.

• Margin

The deposit required when entering into a position as well as to hold an open position. Your margin status can be monitored in the Account Summary.

• NYSE

The New York Stock Exchange.

• Open position

A position in a currency that has not yet been offset. For example, if you have bought 100,000 USDJPY, you have an open position in USDJPY until you offset it by selling 100,000 USDJPY, thus “closing” the position.

• Over the counter

When trading takes place directly between two parties, rather than on an exchange. Over the counter trades can be customised whereas exchange-traded products are often standardised.

• Pips

A pip is the smallest unit by which a Forex cross price quote changes. So if EURUSD bid is now quoted at 0.9767 and it moves up 2 pips, it will be quoted at 0.9769.

• Position

Traders talk of “taking a position” which simply means buying or selling currency cross. “Position” can also refer to a trader's cash/securities/currencies balance, whether he or she is short of cash, has money to lend, is overbought or oversold in a currency, etc.

• Risk

Trying to control outcomes to a known or predictable range of gains or losses. Risk management involves several steps which begin with a sound understanding of one's business and the exposures or risks that have to be covered to protect the value of that business. Then an assessment should be made of the types of variables that can affect the business and how best to protect against unwelcome outcomes. Consideration must also be given to the preferred risk profile – whether one is risk – averse or fairly aggressive in approach. This also involves deciding which instruments to use to manage risk and whether a natural hedge exists that can be used. Once undertaken, a risk-management strategy should be continually assessed for effectiveness and cost.

• Secondary currency (variable currency or counter currency)

The currency that the investor trades the base currency against (i.e. USD in EURUSD).

• Short position

A position that benefits from a decline in market prices.

• Short

To sell.

• Speculative

Buying and selling in the hope of making a profit, rather than doing so for some fundamental business-related need.

• Spot

A Spot rate is the current market price of an asset.

• Spot market

The part of the market calling for spot settlement of transactions. The precise meaning of “spot” will depend on local custom for a commodity, security or currency. In the UK, US and Australian foreign-exchange markets, “spot” means delivery two working days hence.

• Spread

The difference between the bid and the ask rate.