Basic Forex terminology lot, leverage, stop loss

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Basic Forex terminology: lot, leverage, stop loss

Orientation in a new environment is not easy. Perhaps all professions have a minimum terminology outsider won’t understand. Forex is no exception. Let’s take a look at some basic jargon and explain a few terms in our business.

What is “a lot”

A lot is a basic buying or selling investment volume. One lot represents 100 000 units of basic currency, typically US dollar. In the olden days, lots were the only unit to trade with. This was a drastic limitation to small traders. Today, it’s a mere term as you can trade in smaller volumes (micro-lots and nano-lots) or use leverage.

For example, one nanolot equals 100 units. If you don’t use leverage, the number of lots is the only variable you can choose to change the size of investment.

If you open a position equal 1 lot for the currency pair EUR/USD each pip will represent a difference of USD 9.99734. This means that a price movement by 10 pips in your favour will earn you approximately USD 100.

What is margin and leverage

A lot is closely related to two further terms: margin and leverage. Most of you have already heard of leverage trades. If the broker offers you a leverage of 1:100 this means that with USD 1 000 you will be allowed to control up to USD 100 000. One lot will cost you USD 1 000 instead of USD 100 000.

What are these things good for? Of course, for increasing your profit.

If you sell e.g. EUR/CZK without using a leverage and the size of your position is 1 micro-lot (1000 units) and Czech Koruna devaluates by one CZK, you will earn CZK 1 000. Using a leverage of 1:100 the same money will generate you 1 lot – so you have earned hundred times your investment, that is CZK 100 000, which is tempting.

Remember that this rule also works in the opposite direction. If your position includes 1 lot (EUR 100 000) and CZK gets stronger by one CZK you will lose CZK 100 000.

Some brokers allow trading with a 1:1 or 1:400 leverage. But as far as I know, CySEC recently ordered a maximum leverage of 1:10 for all licensed brokers. The more one should be cautious about which broker to chose for trading.

Because leverage trading is used often, the broker will, with each trade, block part of your account called margin. This will protect the broker from a potential loss. As long as the broker feels that the trade is in jeopardy, tehy may make a margin call = to ask you to add cash to your trading account. If you don’t do it or your loss is too high, the trade will close automatically. In fact, this is a good precaution. You may lose the margin and trading account, but at least you are not in debt.

This is also a means of protection for the opposite party. The foreign exchange market is built on the demand and supply principle (by which one side is selling while the opposite one is buying). If you don’t set your stop loss right and your trading account enables falling into red numbers it is likely that after a poor trade you will end up as a debtor! This is a disadvantage of Forex trading against binary options. We have talked about it in the previous article. With binary options, this can never happen.

What is stop loss and take profit?

You must have read, that when trading on Forex markets, losses and profits are unlimited, which is frequently stressed at our website. It is more or less true, which is why every serious trader in this business uses stop loss and take profit. These are price limits at which a trade will close automatically either in profit (take profit) or in loss (stop loss).

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Traders enter the stop loss and take profit orders usually when opening a trade or soon afterwards. The limits should be derived from the trading plan. Once entering the market, you immediately know what you may expect: what profit you might achieve or what loss you are will be able to tolerate. This type of information is available. So why shouldn’t you use it! Once entered, the stop loss and take profit will display on the broker’s screen. Even if you switch off your PC, these levels will remain active. So, you don’t have to fear of your money.

There are loads of terms used by traders in the Forex market. For instance, pip which is the minimum price movement of a given instrument (currency). A lot of these terms are in English. I am sure that you will easily absorb more of the trader’s jargon. However, if you have some questions do not hesitate to ask us in the comments section below.

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I’ve wanted to build a business of some kind and earn money since I was in middle school. I wasn’t very successful though until my senior year in highschool, when I finally started to think about doing online business. Nowadays I profitably trade binary options full-time and thus gladly share my experiences with you. More posts by this author

Forex Trading Terminology: 15 Must Know Terms

If you’re a beginner in the Forex market, chances are you’ve stumbled upon an article or forum post that include terms such as “pips”, “cross-pairs”, “margin” and others.

Those are basic terms of the Forex market that all traders need to know about and understand early in your trading career.

We’ve created a list of the most important Forex trading terminology to help get you started in the market.

While this list is not all-inclusive, it covers the 15 most common terms regularly used by Forex traders.

#1 Currency

The world’s currencies are traded on the Forex market. But let’s start with the very basics – What is a currency?

The word currency is derived from the Latin word “currens”, which means “running” or “in circulation.” A currency is money used as a medium of circulation, such as banknotes and coins. Some sources refer to currencies as a system of money used among people in a nation.

The United Nations currently recognise 180 currencies that are used in 195 countries across the world. Some examples of currencies are the US dollar, the Euro, the British pound and the Japanese yen, which all act as a store of value and which are traded on the global foreign exchange market (Forex).

Just like other assets, the forces of supply and demand determine the value of a currency relative to another currency. Increased supply of a currency sinks its value, while increased demand pushes its value up.

#2 Currency pair

Even though currencies are traded on the Forex market, we’re not able to buy or sell single currencies. Each time we place a trade in the market, we have to trade on currency pairs. Currency pairs consist of two currencies – the first one is the base currency and the second one the counter-currency.

An example of a currency pair is the EUR/USD pair. When we buy the EUR/USD pair, we’re actually buying the euro and selling the US dollar. Similarly, when we sell the EUR/USD pair, we’re actually selling the euro and buying the US dollar.

#3 Major pairs

In general, currency pairs can be grouped into major pairs, cross pair, and exotic pairs. Major pairs are currency pairs that include the US dollar as either the base currency or counter-currency and one of the other seven major currencies (EUR, CAD, GBP, CHF, JPY, AUD, NZD.)

If you’re just beginning with trading, you should focus on the major pairs since they usually offer very low transaction costs and enough liquidity to avoid high slippage. Examples of major pairs are EUR/USD, GBP/USD and USD/CHF.

#4 Cross pairs and exotics

Cross pairs, on the other hand, include any two major currencies except the US dollar. Unlike major pairs, cross pairs have higher transaction costs and, at times of lower liquidity, traders can face slippage. Cross pairs are also usually more volatile than major pairs. Examples of cross pairs include EUR/GBP, EUR/CHF and AUD/NZD.

Finally, exotic pairs include exotic currencies which are not in the Top 10 of the most traded currencies, such as the Mexican peso, Turkish lira or Czech koruna. Since those currencies can be extremely volatile, they should be left to be traded by the pros.

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#5 Exchange rate

The exchange rate of a currency pair is what all traders follow. The exchange rate is often simply called the price, since it shows the price of the base currency expressed in terms of the counter-currency. For example, if the exchange rate of EUR/USD is 1.15, this means that one euro costs $1.15, or it takes $1.15 to buy one euro.

A rise in the exchange rate of a currency pair shows that the base currency is appreciating against the counter-currency or that the counter-currency is depreciating against the base currency. Similarly, a fall in the exchange rate shows that the base currency is depreciating against the counter-currency or that the counter-currency is appreciating against the base currency.

#6 Bid/Ask price

At any given moment, each currency pair has two exchange rates or prices – the bid price and the ask price. What’s the difference between those two? The bid price is the price at which buyers are willing to buy, while the ask price is the price at which sellers are willing to sell.

Given its nature, the bid price is always lower than the ask price. Once those two prices meet, either when sellers lower their ask price to meet a buyer’s bid price or when buyers increase their rate they’re willing to pay for a currency and meet a seller’s ask price, a transaction occurs.

In the end, buyers buy at the ask price, and sellers sell at the bid price. This means that each price plotted on your chart represents the market equilibrium at that point of time – the price at which the majority of market participants are willing to transact.

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#7 Spread

Each time you enter into a trade, you have the pay transaction costs for that trade. While most brokers don’t charge commissions and fees on placing trades nowadays, the bid/ask spread remains the main cost to Forex traders. When bulls buy at the ask price (the price at which sellers are willing to sell), their position is immediately in a loss that equals the bid/ask spread.

If you’re a day trader or scalper, you need to pay attention to the bid/ask spread since it can eat a large portion of your profits at the end of the day. Swing traders and position traders who have a longer-term approach to trading are less affected by the spread as they open a smaller number of positions and have relatively higher profit targets.

#8 Pip

When Forex traders talk about profits or losses, they usually use the term “pips”. A pip is short from Percentage in Point and represents the smallest increment that an exchange rate can move up or down. Usually, one pip equals to the fourth decimal of most currency pairs.

For example, if EUR/USD is currently trading at 1.1558 and rises to 1.1562, that rise would equal to a change of 4 pips. However, some currency pairs have their pips located at the second decimal place, mostly yen-pairs. If USD/JPY currently trades at 110.25 and falls to 110.10, that fall would equal to a change of 15 pips.

#9 Pipette

A pip represents the fourth decimal place of most currency pairs, but there is an even smaller increment that prices can change. It’s called a pipette and equals 1/10 of a pip, i.e. 10 pipettes are one pip. A pipette is located at the fifth decimal place of most pairs (in yen-pairs, they’re at the third decimal place.)

Most traders don’t follow movements in pipettes, even though some brokers use them in their trading platform. Today, pipettes are mostly used to measure the bid/ask spread, where a tenth of a pip is needed. For example, the spread in EUR/USD might be 1.4 pips, or one pip and four pipettes.

#10 Going long/short

You’ve probably heard about going long or short in a currency pair. Going long simply means to buy, while going short means to sell. In equity markets, most traders are long in anticipation of rising prices. However, in derivative markets, such as options and futures, there is always an equal number of longs and shorts in the market, because each new contract that is bought needs a corresponding seller who needs to go short, and vice-versa.

Since retail Forex is mostly traded with CFDs, traders are able to bet both on rising prices and falling prices. When buying, they’re going “long”, and when short-selling, they’re going “short”.

#11 Support

Support and resistance are one of the most important concepts in technical analysis. Technical traders analyse only price-moves as they believe that the price reflects are available fundamental information, and support and resistance trading plays an important role in that analysis.

The markets are made of crowds of people that speculate, hedge, trade, invest or gamble in the markets. Since people have memory, they remember certain price-levels where the price had difficulties to break below in the past.

They place their buy orders around those levels, as they believe that the price will again fail to break below. This is how support levels are formed. In other words, a support level is a previous low at which the price has a large chance to retrace and move up.

#12 Resistance

Just like support levels, resistance levels are also a crucial tool in a technical trader’s toolbox. While support levels are based on previous lows, resistance levels track previous highs at which the price had difficulties to break above.

Traders remember those levels and place their sell orders around them, as they believe that those levels will again provide selling pressure and move the price down. Since fresh memory is more important than old memory, recent support and resistance levels usually have a higher importance than old support and resistance levels.

#13 Leverage

The Forex market is open around the clock and offers traders to profit not only on rising prices, but also on falling ones. However, there is another reason why a large number of traders feel attracted to the Forex market – leverage.

Trading on leverage allows traders to open a much larger position size than their initial trading account size would otherwise allow, and the Forex market is known for extremely high leverage ratios offered by retail brokers.

Watch: Is Leverage a True Friend or Foe?

However, bear in mind that trading on extremely high leverage is very risky, as it boosts not only your profits, but also your losses. Beginners should consider trading on a lower leverage until they gain enough experience and screen time. This will reduce losses and make sure that you stay in the game in the long run.

#14 Margin

When trading on leverage, your broker will allocate a portion of your trading account size as the collateral for the leveraged trade. This collateral is called “margin” and its size depends on the leverage ratio that you’re trading on. A leverage ratio of 100:1 asks for a margin that equals 1% of your position size.

What’s important when trading on leverage is to always keep an eye on your free margin. Your free margin equals your total equity (account size + any unrealized profits/losses), minus your used margin. If your free margin drops to zero, you’ll receive a margin call and all your open trades will be closed at the current market rate.

Discover more about risk:

#15 Lot size

The position size you take on the market determines the size of your profits and losses in dollar value by affecting the value of a single pip. In the Forex market, one standard lot (standard position size) equals to 100.000 units of the base currency. For example, if you take one standard lot in the EUR/USD pair, you’re actually trading 100,000 euros with a pip-value equal to $10.

Fortunately, traders with smaller account sizes can take smaller trades with mini-lots (10.000 units of the base currency) and micro-lots (1.000 units of the base currency.) Some brokers even allow you to trade on nano-lots (100 units of the base currency.) In any case, calculate your lot size in dependence of the size of your stop-loss so that you remain inside your risk-management boundaries.

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Basic forex terminology

Before you start trading forex, it’s important to familiarise yourself with the basic forex terminology. There is plenty to learn, but below is a quick look at some of the most common terms used by traders. Please see our Glossary for further terminology

Currency pair → forex is traded in currency pairs: one currency is bought, the other is sold. Together they make up the exchange rate.

Exchange rate → the rate of which one country’s currency can be exchanged for another currency

Base currency → the currency that comes first in the currency pair (e.g. in GBPUSD the GBP is the base currency)

Quote currency → the second currency quoted in a currency pair (e.g. in GBPUSD the quote currency is USD)

Long position (buy) → a long position refers to the purchase of an asset, with the expectation that its market value is set to rise

Short position (sell) → a short position refers to the sale of an asset, with the expectation that its market value is set to fall

Bid price → the market price for the sale of an asset

Ask price → the market price for purchasing an asset

Spread → the difference between the “bid” and “ask” prices (the selling price and the purchase price).

Appreciation → an increase in the value of an exchange rate

Depreciation/devaluation → a decrease in the value of an exchange rate

Gapping → An opening price significantly above or below the previous day’s close with no trading activity in between. This means that a limit or stop order could be filled at a price different from the desired order price.

Pips → a pip stands for “percentage in point”, and is the smallest price movement any exchange rate can make. It measures the amount of change in the exchange rate for a currency pair in the forex market. A pip is the fourth and final number after the decimal point (with the exception of Japanese yen-based currency pairs, which are displayed to only two decimal points). Pips are the means by which market profits and losses are quantified

Lot → forex is traded in lots. A standard lot is equivalent to 100,000 units of the base currency. This is $100,000 if you were trading in US dollars. A mini lot has 10,000 and a micro lot has 1,000 units.

Leverage → Leverage is a way for an investor to increase their trading power and manage a greater position on the market with a nominal investment. An online broker may offer leveraged trading for up to 30 times the value of a trader’s initial investment.

Margin → the minimum deposit needed to maintain an open position (e.g. with an open position of $150,000 and leverage of 30, the required margin is $5,000).

Risk management → involves the use of strategies in order to help control or reduce financial risk. An example is a stop-loss order which is used to potentially minimise losses on a trade.

Stop loss → a stop loss order is a risk management tool allowing a position to be closed, once it reaches a specific pre-set price. This can protect against further losses on an open position if prices continue in an unfavourable direction for the investor. Please note, that placing a normal stop loss order does not guarantee you will be filled at that particular market price due to slippage.

Take profit → a take profit order is a risk management tool allowing a position to be closed automatically, once it reaches a specific pre-set profit goal. This can protect against profits being lost in an unanticipated reversal of price direction before the investor can close the position.

Profit/Loss → the proceeds of a trade, which are from realised (closed) trade positions.

For a more in-depth look at common words, terms and useful phrases associated with trading and the financial markets, please visit our Trading Glossary page.

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