Basic Terms Every Forex Trader Should Know
Forex trading is an exciting, crazy endeavor with potential for great reward. This unique investment market is filled with many terms not used in any other financial activity. While trading stocks can give you the edge, there are a few terms even experienced traders may not understand.
Forex stands for foreign exchange and designates a market where traders move trillions of dollars back and forth 24 hours a day for six days a week. Not only individuals but banks and even governments get involved in the Forex market when it is in session. This fast-paced environment means that fortunes can be gained or lost in just a few seconds.
A currency pair is two types of money from two different countries that are traded for each other. Some common examples include the British pound and US dollar or the Canadian dollar and Japanese yen. While any two currencies can be paired together, seven major currencies are the most popular on the Forex market. They include the following:
- US dollar
- British pound
- Canadian dollar
- Japanese yen
- Australian dollar
- Mexican pesos
The spread is where brokers make a profit. All traders must use a broker, and the spread is the difference in the selling price and buying price. To tell if you are making a profit, the currency you have must have a higher number than the one you are trading for.
The pip is a measurement for currencies. It’s the smallest unit, which is the furthest right from the decimal point. In some currencies this will be four digits and in others it will be two digits to the right. While one pip is a small amount of money, it provides leverage for your trading.
Leverage is the amount of money you must have compared to how much you can trade with. One of the benefits of the Forex market is that it allows you to use a lot of leverage. Of course, this also increases the risk of trading as well.
Margins are the amounts an investor can trade with a broker while investing only a portion. For instance, a trader can invest $10,000 to trade $50,000, which allows them to make more money. With a margin call, a trader must pay back all of the money they have borrowed, which may lead to major losses.
A stop loss is an important tool in Forex trading. It allows you to stop your trade at a certain point. A trailing stop loss allows your trade to continue to make money, but it will protect your profit if the trade starts to move in the wrong direction.
Long versus Short
Trading long means that a trader holds the currency for at least a week or even longer. When they trade short, they are buying the currency which is trading against the short currency.
It’s important to understand the basic terms in Forex and how they work. Without this knowledge, all you will learn is how a loss works.