Forex Lesson-4 Main terms
Wow, you’ve got to lesson 4! It means that your intentions are serious. Great! Let’s go through the main terms that every trader needs to know. The explanations below will help you manage your money and risks in order to get the most out of your trades.
A lot is just some units of the asset you trade, be it a currency pair, a stock, or an index.
In Forex trading, one standard lot equals 100,000 base currency units. It means that if you want to trade 1 lot of EUR/USD, you will need 100,000 euro. Besides, there is a mini lot (10,000 units) and a micro lot (1000 units).
For stocks, 1 lot usually equals 100, for indices it’s 10.
As you probably remember from the previous lesson, when you open a trade, you need to choose its volume. ‘1’ in volume stands for 1 lot. The smallest position you may open is 0.01 lots. For currency pairs, that stands for about $1,000.
Relax, you don’t need so much money to trade! Frankly speaking, you can start trading with just $1, because you will be able to use the so-called ‘leverage’. For now, just keep this information about lots in mind, later you’ll understand everything.
Points represent the smallest change an asset can make. A pair is counted in five decimal points, for example, a quote of GBP/USD is given like this: 1.37465. On August 19, the pair dropped from 1.37465 to 1.36300. In other words, it fell by 1165 points. Another example: on August 16, GBP/USD plunged from 1.38570 to 1.38400. The decline was 170 points.
Indeed, pairs with the JPY have three decimal points. For example, the US dollar/Japanese yen is quoted as 103.705. A point is represented by the last decimal of a price/quotation.
Not really. A point refers to the fifth decimal, whereas a pip refers to the fourth decimal in currency pairs like EUR/USD. It’s different for the pairs based on the USD like USD/JPY: a point refers to the third decimal, while a pip refers to the second decimal. In other words, 1 pip equals 10 points.
Well, that’s a good question. Let’s say, you want to trade USD/JPY and its exchange rate is 103.800.
0.001 (a point) / 103.800 (an exchange rate) x 100 000 (a standard lot) = $0.96 per point
Indeed, let’s count a pair where the USD is a quote currency like EUR/USD. It’s much easier as we even don’t need to take into consideration the current exchange rate.
0.00001 / 1 x 100 000 = $1 per point
Not at all! As we already said above, the minimum deposit at FBS is $1. A trader needs $1000 to open an order with one micro lot. The good news is that brokers have found a way out – leverage. A broker will provide a trader with $999 on a trader’s $1 if leverage is 1:1000.
Exactly! You do not have to invest all this money by yourself – you may borrow them from your broker.
In FBS, leverage can vary for different accounts that you have – it can be accessed through personal area and changed in the Account settings. You need to choose leverage that suites you for your skills: bear in mind that while leverage multiplies your potential profit, it also increases your loss if the market goes against you.
Now that you know what leverage is, the margin will be easy! In Forex trading, a margin is a sum of money that is required from a trader to open a position.
The $1 a trader provides in case of using 1:1000 leverage in the example above is the margin.
The funds that you hold in your trading account are the money you can use as a margin. Margin value will depend on the leverage ratio that the trader chooses as well as the trade size.
Your trading platform will show you free margin (or usable margin) and margin level figures. Free margin is the money that you have in your account that can be used to maintain your open positions or open new ones. Margin level is the ratio of your Equity to the Used Margin of your open positions, indicated as a percentage.
In a healthy account, the margin level is always above 100%.
Rollover is a process when the position is held open overnight. When that happens, the interest rates of the currencies in the FX pair are counted against each other. Depending on the interest rates, a trader is either credited or charged a particular sum.
The sum that the trader can gain or lose due to rollover is called swap. The rollover may result in swap benefits or swap charges, depending on the interest rate differentials. The interest rate of each currency is set by that country’s central bank. Usually, the interest rates are influenced by major economic events in the country, which you can monitor in the economic calendar.
The swap rate is the interest rate of one currency in the pair minus the interest rate of the other one. Which currency you subtract from depends on the kind of trade you’re opening: long or short.
Long trade (or bullish trade) is basically when you buy the asset expecting it will increase its value.
Short trade (or bearish trade) is the opposite: you sell the asset anticipating it will lose its value.
So, if you are going long on EUR/USD (buying euro and selling the US dollar), the dollar interest rate is subtracted from the euro interest rate. For a sell trade in EUR/USD, the euro interest rate is subtracted from the dollar interest rate.
Thankfully, you don’t need to manually calculate the swap every time you engage in trading: there are special tools for that. You can check swap rates in each trade instrument’s specification.
There are two special orders, which serve to close a trade: Take Profit order or TP and Stop Loss order or SL. These orders make trading results more predictable.
A Stop Loss is an exit order, which is used to limit the amount of loss that a trader may take on a trade if the market goes against them.
When you open an order, it’s better to minimize the possible risks. So, if you are going to open a buy order, place Stop Loss below the current price so that if the price falls, your Stop order will automatically close you out of that trade protecting you from losing more.
Successful risk management means that the losses are minimized. Stop Loss can be an efficient solution for that. If you’ve decided to use a Stop Loss order, it’s very important to find a good place for it. The simplest way is to place SL for a buy trade at the previous low. To learn other approaches, read our article “How to place a Stop Loss order”.
Let’s say you expect the price to go up, and you want to open a buy order. If your forecast is right, the price will rise. However, it won’t rise forever, but will reverse down at some point. That’s why you can use a TP that will close your positions before the price reverses.
In other words, TP is a profit target. You need to place TP at the level you expect the price to reach (it is often the previous high). If you buy, TP will be above the current price. If you sell it will be below it. That’s it! Easy, right?
- Currency pairs are traded in lots. One standard lot on Forex equals 100,000 base or account currency units.
- A point represent the smallest change the price can make.
- A trader can use leverage to increase the amount of capital to trade.
- Proper risk management means that losses should be minimized, while profit is maximized, that’s why traders should use Take Profit and Stop Loss orders.
Next, you will be able to use the terms you have just learned to understand how trading profit is calculated.
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