Key Terms Every New Trader Should Know

For new traders, foreign exchange (Forex) trading can very well seem complex and confusing due to the funny jargon and concepts related to it. Nevertheless, anyone who wishes to trade currencies successfully needs to know some basic terms and principles. If this is your first commentary on forex, then this small Forex learning course will get you acquainted with the main forex terminology and concepts that every new trader must know.

What is Forex Trading?

Currencies are traded internationally; this is known as Forex (FX). It is speculating on currency pair exchange rates based on whether you think one currency will rise or fall against the other currency. For instance, you might bet that the US dollar will lose value against the euro. Should you make the correct prediction, you earn a profit. If not, you take a loss.

Trading in the Forex market is done digitally all over the world. It has daily trading volumes of US $7.5 trillion per day — larger than all other financial markets combined. The major benefit for traders is this high liquidity.

Currency Pairs

Currencies are always traded in pairs – for example, EUR/USD (Euro/US Dollar). The first listed currency of a currency pair is called the base currency, while the second is called the quote or counter currency.

When you buy or sell a currency pair, you are speculating on whether the base currency will rise or fall against the quote currency. For EUR/USD, if you think the Euro will strengthen relative to the US dollar, you would buy EUR/USD. If you think it will weaken, you will sell EUR/USD.

There are four main types of currency pairs:

• Major pairs. Most traded pairs involve USD, EUR, JPY, GBP, etc.
• Minor pairs. Include major currencies except USD or EUR.
• Exotic pairs. Include one major and one emerging economy currency.
• Pairs that do not involve USD – e.g., EUR/JPY, GBP/AUD.

Knowing the characteristics of different currency pairs helps traders pick pairs aligned with their strategies.

Pips

A “pip” stands for “percentage in point” and represents the smallest increment that a currency pair can move in price. Most pairs are quoted out to four decimal places – the 4th decimal place represents a 1 pip change. For example, if EUR/USD moves from 1.1200 to 1.1201 – it has moved up 1 pip. JPY pairs are quoted out to two decimal places, representing a 1 pip change.

Pip movements represent your profit or losses on a trade. A 10-pip gain means you have made 10 units of profit based on trade size.

Bid and Ask Prices

All Forex currency pairs have two prices – the bid price and the ask price. The bid is the price at which you can sell a currency pair. The question is about the price at which you can buy it. The ask will always be slightly higher than the bid due to the spread between them.

For example, the bid price for EUR/USD might be 1.1200 while the ask price is 1.1201. If you wanted to buy EUR/USD, you would pay the higher asking price of 1.1201.

Spread

The spread represents the transaction cost paid to your broker on every trade. As mentioned above, it refers to the difference between the bid and ask price. Spreads widen and tighten based on market conditions and volatility.

The tightest spreads are offered on major currency pairs during liquid trading sessions, such as the London and New York overlaps. Exotic pairs typically have much wider spreads due to lower liquidity. Traders need to factor spreads into profit calculations on every trade.

Leverage and Margin

Leverage allows Forex traders to open much larger positions than their account balance would normally allow by only putting up a small deposit called a margin. Leverage is shown as a ratio – for example, 100:1. This means your broker will lend you $100 for every $1 you deposit. Margin is usually around 1% of the total trade size.

If you have a 1,000 account balance and 100:1 leverage, you could control a $100,000 position while only tying up 1% ($1,000) of that margin. However, leverage magnifies both profits and losses, so it’s a double-edged sword.

Lot Size

Forex lot sizes represent the number of currency units you will buy or sell on a trade. Standard lot sizes are 100,000 units, so one standard lot of EUR/USD represents €100,000 in value. Mini lots are 10,000 units, while micro lots are 1,000 units.

Lot sizes determine your profit or loss per pip movement. One pip movement on a micro lot would make you $0.10 profit or loss. One pip on a standard lot is 10. As lot sizes increase, pip value increases.

Long/Short

When you buy a currency pair, you go “long,” hoping to profit from rising prices. This means you expect the base currency to rise compared to the quote currency. For example, if EUR/USD is trading at 1.1200 and you think it will increase to 1.1500, you would go long.

You go “short” when you sell a currency pair, betting on prices moving down. You expect the base currency to weaken compared to the quote currency. If you think EUR/USD will fall from 1.1200 to 1.1100, you would take a short position by selling it.

Technical vs. Fundamental Analysis

There are two main approaches to analyzing the markets: technical analysis and fundamental analysis. Both can be useful either independently or in combination.

Technical analysis involves using historical price charts and technical indicators to predict future movements. The chart pattern and trends identify traders’ entry and exit levels.

Fundamental analysis involves financial and social analysis of a particular currency. Thus, these are among interest rates, economic growth, inflation, central bank policy, and geopolitics. News and data help traders to analyze market sentiment.

Some traders use technical signals to time entries and exits, and others use fundamentals to understand the behavior of the market in general. As an example, if economic data deteriorates, a trader may take a fundamental stance and favor short positions because of a possible recession. However, they would then use technical tools to identify exactly when to execute those shorts based on the price action.

Order Types

There are several order types in Forex trading used to manage trades. The main types are:

• Market Order. This executes your buy or sell trade immediately at the current market price. Simple to use but does not control the price.
• Limit Order. This allows you to set a price level at which you want to enter or exit. The trade won’t execute until the price reaches the limit. Useful for profit-taking or buying dips.
• Stop Loss Order. This sets the maximum loss you’re willing to take on trade by closing out your position if the price moves against you by a specified amount. Critical for risk management.
• Take Profit Order. This closes part or all of your position once the price reaches a predefined profit level. Lets you systematically take profits as the market moves in your favor.
• Trailing Stop Loss. A special stop loss that automatically tracks the price movement of profitable positions, closing them if the market reverses by a set percentage. Very useful for maximizing winning trades.

Understanding how and when to apply different order types is an essential Forex trading skill.

Account Types

There are a few main types of trading accounts to be aware of:

Demo Account. Allows virtual paper trading with fake money to practice strategies risk-free. Vital for new traders.

Standard Account. Real money account that offers full access to the live markets along with basic features and average spreads.

ECN Account. Typically requires a higher minimum deposit but offers direct access to the Forex market with super tight spreads and raw spreads that can be negative during volatile periods. Useful for high-frequency traders.

Many brokers offer Islamic accounts that comply with Sharia law and other specialty account types, such as managed accounts.

Risk Management Strategies

The most important thing in successful Forex trading over the long run is risk management. No matter how good you become in analysis or developing trading systems, you will eventually lose your entire account if you don’t have effective risk mitigation. Key risk management strategies include:

• Appropriate Position Sizing. There is no trade that can risk more than 1-2% of your account value. Thus, you can manage normal market volatility and drawdowns without being allowed to be wiped out.
• Using Stop Losses. Keep stopping losses on every trade; if the market moves against the trade, then the potential losses are contained. Stops don’t guarantee your exit price, but they are vital.
• Limiting Leverage. The reduction of leverage more than reduces the amplification of the loss during a market reversal and prevents margin calls.
• Trading multiple uncorrelated currency pairs and asset classes smooths equity curves, so one single trade won’t cripple you.

Making ongoing refinements to your risk management strategy is imperative as you progress in your trading career.

Forex Market Sessions

The Forex market runs 24 hours a day during weekdays, but trading volumes and volatility vary widely based on geography and time of day. The main sessions are:

Sydney

Opens at 5 PM EST and trades modestly due to most participants being European traders at the end of their day. Good session for trading AUD and NZD pairs.

Tokyo

This was a very volatile session with high volume as Asian markets opened. The JPY pairs saw heightened activity. The session runs from 7 PM to 4 AM EST.

London

The capital of Forex trading opens at 3 AM EST with huge volume and volatility, especially on GBP and EUR pairs, as European traders enter the market. Overlaps with the New York session.

New York

A very liquid session for USD and CAD pairs with Wall Street entering from 8 AM – 5 PM EST. Overlaps with London during the morning.

Analyzing average volatility by a session can lead traders towards more profitable times to trade specific currency pairs.

Forex vs Stocks

While Forex trading shares some similarities with stock market trading, there are critical differences to understand, including:

• Market Access. The stock market has clearly defined trading hours, whereas Forex trades 24 hours a day. Stocks trade on centralized exchanges, whereas Forex is decentralized.
• Forex offers much higher leverage. While 50:1 leverage is common for stocks, 500:1 leverage is possible in Forex, allowing for bigger position sizes.
• Trading Costs. Forex has no commissions beyond spreads. Stock trades incur commission fees and higher transaction costs per trade, which limit the profit potential of small moves.
• Profit Potential. The profit potential is very high because there are no limits to how much prices can move in Forex. A company’s valuation and earnings limit stocks.
• Technical analysis dominates forex trading for stocks, while the terms forex analysis, forex trade and forex trading are more heavily weighted in forex trading.

This helps traders to concentrate on the market that is most appropriate for their trading style and objectives.

Key Takeaways for New Forex Traders

A solid starting foundation for trading currencies profitably is learning some key terms and concepts that will get you into the game and help you on your way. You’ll need to learn a lot of education, spend a lot of time on the screen, and develop skills to make it successful, but there’s a starting point with some of these. The basics included in this guide are as follows:

• What Forex trading is and how to analyze currency pairs
• How to calculate pips, spreads, leverage and position sizing
• Different order types and trading sessions
• Fundamental vs technical analysis
• Risk management principles

These core building blocks should be internalized so that you can learn quickly and quickly become a successful Forex trader.