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The foreign exchange market, also referred to as forex or FX, is the global currency trading market. It is the largest, most liquid financial market in the world.
When trading forex, currencies are traded in pairs. For example, the Australian dollar and the U.S. dollar (AUD/USD) or the euro and the Japanese yen (EUR/JPY).
A currency pair consists of a base currency and a quote currency (or counter currency). It is a way to display and price one currency against another.
Currency pairs are conventionally shown as two abbreviated currency names, separated by a slash. For example, with the”EUR/USD” currency pair, the euro (EUR) is the base currency and U.S. dollar (USD) is the quote currency.
The most frequently traded currency pairs in the world are called the majors. These pairs all contain the U.S. dollar (USD) on one side.
The major currencies include the euro, U.S. dollar, British pound sterling, Canadian dollar, Swiss franc, Japanese yen, Australian dollar, and New Zealand dollar.
A minor currency pair is one which does not contain the US dollar. These pairs are also known as a “cross-currency” pairs or simply as “crosses“.
Examples of minor currency pairs include EUR/GBP, EUR/AUD and GBP/JPY.
The most actively traded crosses are derived from the euro (EUR), Japanese yen (JPY), and the British pound sterling (GBP).
A pip (percentage in points) is the term used in the forex market to represent the smallest incremental move an exchange rate can make.
For example, if an exchange rate was previously 1.2510 and increased by one pip, the exchange rate will be 1.2511.
Currency pairs are traded in specific amounts called lots, which are the number of currency units you wish to buy or sell.
The standard size for a lot is 100,000 units of currency. There also a mini, micro, and nano lot sizes that are 10,000, 1,000, and 100 units respectively.
The bid price represents the price that a buyer is willing to pay.
For example, if you are in a long EUR/USD position, and you now want to exit right now, the bid price is the price you will accept to get out of the trade.
The ask price represents the price that a seller is willing to accept.
For example, if you want to open a new trade and go long EUR/USD, the ask price is the price you will pay to buy EUR/USD.
The spread is the difference between the bid and the ask price.
The bid is the price in the market that a buyer will pay, and the ask is the price a seller is willing to accept.
For example, the USD/JPY bid/ask spread is 110.00 / 110.02. Currency pairs that are less actively traded have wider spreads.
An uptick is a new price quote higher than the previous quote.
For instance, if EUR/USD traded at $.1510, and the next trade occurs at a price above $1.510, EUR/USD is on an uptick.
A downtick is a new price quote lower than the previous quote.
For example, if EUR/USD traded at $.1510, and the next trade occurs at a price below $1.510, EUR/USD is on a downtick.
Slippage occurs when you wish to enter the market at a certain price, but due to the extreme volatility during these events, you actually get filled at a far different price.
Slippage is the difference between the expected fill price and the actual fill price. If the actual fill price is better than the expected fill price, this is referred to as “positive slippage“. If the actual fill price is worse than the price requested, this is known as “negative slippage“.
Traders usually experience negative slippage in highly volatile markets such as during news or economic releases. This is why you should be careful when trading the news.
A long position is when a trader opens a trade and the base currency is bought.
For example, if you “long EUR/USD“, this means you are buying the euru, and selling the U.S. dollar. The euro (EUR) is the base currency and the U.S. dollar (USD) is the quote currency.
A short position is when a trader opens a trade and the base currency is sold.
For example, if you “short EUR/USD“, this means you are selling the euru, and buying the U.S. dollar. The euro (EUR) is the base currency and the U.S. dollar (USD) is the quote currency.
The term “bullish” is a term used to describe when a trader’s outlook on an asset is positive and will rise in price.
For example, if you are “bullish” on the Japanese yen (JPY), it means you think the yen will strengthen and its price will go up.
The term “bearish” is a term used to describe when a trader’s outlook on an asset is negative and will fall in price.
For example, if you are “bearish” on the Japanese yen (JPY), it means you think the yen will weaken and its price will go down.
Margin is basically collateral to open and maintain a position. Before you place a trade, you are required to make a deposit into your margin account. The amount depends on the margin percentages required by your broker to trade leveraged positions.
Leverage is having the ability to control a large amount of money using none or very little of your own money and borrowing the rest.
The use of leverage allows traders to trade in bigger sizes allowing higher potential return (and losses) than otherwise would have been possible.
It’s crucial to understand how leverage should be used safely.
Rollover is the interest paid or earned by a trader for holding a position overnight. Interest is paid on the currency that is borrowed and earned on the one that is bought.
Since every currency trade involves borrowing one currency to buy another, interest rollover charges are part of forex trading.
Currency prices are affected by multiple economic and political factors, like economic growth, interest rates, inflation, and political stability. You can learn more by reading our lessons on Fundamental Analysis.
Governments may also try to directly influence the value of their currencies, either by buying up their domestic currency on the market in an attempt to raise the price or by increasing supply of their domestic currency in an attempt to lower the price. This is known as central bank intervention.