As in any worthwhile endeavor, each industry tends to create its own unique lingo. The FOREX market is no different. You, the novice trader, must thoroughly comprehend certain terms before making your first trade.
Currency Pairs
Every FOREX trade involves the simultaneously buying of one currency and the selling of another currency. These two currencies are always referred to as the currency pair in a trade.
Major and Minor Currencies
The seven most frequently traded currencies (USD, EUR, JPY, GBP, CHF, CAD, and AUD) are called the major currencies. All other currencies are referred to as minor currencies. The most frequent traded minor are the New Zealand dollar (NZD), the South African rand (ZAR), and the Singapore dollar (SGD). After that, the frequency is difficult to ascertain because of perpetually changing trade agreements in the international arena.
Cross Currency
A cross currency is any pair in which neither currency is the US dollar. These pairs may exhibit erratic price behavior since the trader has, in effect, initiated two USD trades. For example, initiating a long (buy) EUR/GBP trade is equivalent to buying a EUR/USD currency pair and selling a GBP/USD. Cross currency pairs frequently carry a higher transaction cost. The three most frequently traded cross rates are EUR/JPY, GBP/EUR, and GBP/JPY.
Base Currency
The base currency is the first currency in any currency pair. It shows how much the base currency is worth as measured against the second currency. For example, if the USD/CHF rate equals 1.6215, then one USD is worth CHF 1.6215. In the FOREX markets, the US dollar is normally considered the “base” currency for quotes, meaning that quotes are expressed as a unit of $1 USD per the other currency quoted in the pair. The primary exceptions to this rule are the British pound, the Euro, and the Australian dollar.
Quote Currency
The quote currency is the second currency in any currency pair. This is frequently called the pip currency and any unrealized profit or loss is expressed in this currency.
Pips
A pip is the smallest unit of a price for any foreign currency. Nearly all currency pairs consist of five significant digits and most pairs have the decimal point immediately after the first digit, that is EUR/USD equals 1.2812. In this instance, a single pip equals the smallest change in the fourth decimal place, that is, 0.0001. Therefore, if the quote currency in any pair is USD, then one pip always equals 1/100 of a cent.
One notable exception is the USD/JPY pair where a pip equals $0.01 (one US dollar equals approximately 107.19 Japanese yen). Pips are sometimes called points.
Margin
When an investor opens a new margin account with a FOREX broker, he or she must deposit minimum amount of monies with that broker. This minimum varies from broker to broker and can be as low as $100.00 to as high as $100,000.00.
Each time the trader executes a new trade, a certain percentage of the account balance in the margin account will be earmarked as the initial margin requirement for the new trade based upon the underlying currency pair, its current price, and the number of units traded, (called a lot). The lot size always refers to the base currency. An even lot is usually a quantity of 100,000 units, but most brokers permit investors to trade in odd lots (fractions of 100,000 units).
Leverage
Leverage is the ratio of the amount used in a transaction to the required security deposit (margin). It is the ability to control large dollar amounts of a security with a comparatively small amount of capital. Leveraging varies dramatically with different brokers, ranging from 10:1 to 400:1. Leverage is frequently referred to as gearing.
Bid Price
The bid price is the price at which the market is prepared to buy specific currency pair in the in the FOREX market. At this price, the trader can sell the base currency. It is shown on the left side of the quotation. For example, in the quote USD/CHF 1.4527/1.4532, the bid price is 1.4527; meaning you can sell on US dollar for 1.4527 Swiss francs.
Ask Price
The ask is the price at which the market is prepared to sell as specific currency pair in the FOREX market. At this price, the trader can buy the base currency. It is shown on the right side of the quotation. For example, in the quote USD/CHF 1.4527/1.4532, the ask price is 1.4532; meaning you can buy one US dollar for 1.4532 Swiss francs. The ask price is also called the offer price.
Bid/Ask Spread
The spread is the difference between the bid and ask price. The “big figure quote” is the dealer expression referring to the first few digits of an exchange rate. These digits are often omitted in dealer quotes. For example, a USD/JPY rate might be 117.30/117.35, but would be quoted verbally without the first three digits as “30/35”.
Rollover
Rollover is the process whereby the settlement of an open trade is rolled forward to another value date. The cost of this process is based on the interest rate differential of the two currencies.
CONCLUSION
Trading currencies on margin lets you increase your buying power. If you have $2,000 cash in margin account that allows 100:1 leverage, you could purchase up to $200,000 worth of currency because you only have to post one percent of the purchase price as collateral. Another way of saying this is that you have $200,000 in buying power.
With more buying power, you can increase your total return on investment with less cash outlay. To be sure, trading on margin magnifies your profits and your losses.