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Forex Trading Terms Explained

Forex Trading Terms Explained

Place/Modify/delete Stop Loss & Take Profit Orders

Stop Loss – a pending order to close a position that is moving against you should the market price reach a predefined level.

Take Profit – a pending order to close a position that is moving in your favor should the market price reach a predefined level.

If you place these types of orders you do not have to sit in front of your computer and wait for the outcome.

Take Profit and Stop Loss orders will be executed automatically as soon as the price reaches
the order level.

You can place Stop Loss and Take Profit at the time of making a deal by filling in the “Stop Loss” and “Take Profit” fields in the “Order” window: In order to delete Stop Loss or Take profit orders specify its level as equal to zero.

What are PIPS?

One pip is the smallest unit of change in price. It stands for ‘percentage in point’. Because most
currency pairs are quoted with four decimal points, one pip usually equals 0.0001.

A pip is usually the last decimal place of a price quote.

Most pairs go out to 4 decimal places, but there are some exceptions like Japanese yen pairs (they go out to two decimal places).

For example, for EUR/USD, it is 0.0001, and for USD/JPY, it is 0.01.

Let’s look at a EUR/USD example. If the price moves from 1.2880 to 1.2900, it has gone up by 20 pips. If it goes from 1.2880 down to 1.2820, it’s gone down by 60 pips.

Pips provide an easy way to calculate the profit or loss (also known as the P&L) on a trade.

 

Spread

The spread is the difference between the bid price and the ask price.

The bid price is the rate at which you can sell a currency pair and the ask price is the rate at which you can buy a currency pair (EUR/USD).

Whenever you try to trade any currency pair, you will notice that there are two prices shown.

The spread is essentially the cost of your trading.

You may come across brokers advertising low spreads but be sure to check what other commissions and costs they may be charging you.

What is Lot

Forex is commonly traded in specific amounts called lots, or basically the number of currency units you will buy or sell.

A lot is a unit to measure the amount of the deal. Your value of your trade always corresponds to an integer number of lots (lot size * number of lots).

Trading with the proper position or lot size on each trade is key to successful forex trading.

The position size refers to how many lots (micro, mini or standard) you take on a particular trade.

The standard size for a lot is 100,000 units of base currency in a forex trade, and now we have mini, micro and nano lot sizes that are 10,000, 1,000 and 100 units respectively.

What is long in forex trade?

Whenever you purchase (buy) a currency pair, it is called going long.

When a currency pair is long, the first currency is purchased (indicating, you are bullish) while the second is sold short (indicating, you are bearish).

For example, if you are purchasing a EUR/USD currency pair, you expect that the price of Euro will go high and the price of USD will go down.

What is short in forex trade?

When you go short on a forex, the first currency is sold while the second currency is bought.

To go short on a currency means you sell it hoping that its prices will decline in future.

In forex trade, whether you are making “long” (buying a currency pair) or “short” (selling a currency pair) trades, you are always long on one currency and short on another.

Therefore, if you sell, or go short on USD/JPY, then you are long on JPY and short on USD.

It means you expect the prices of JPY (Japanese yen) will rise and the price of the USD (US dollar) will fall.

 

Leverage

Through the use of leverage, traders are able to invest a small amount of money and trade much larger deal sizes.

This is useful because the movement in currency rates can be very small, and larger trades represent larger profits/losses for every pip change in the rate.

Leverage allows you to trade with more money than you have in your account, because you effectively “leverage” your free balance to open a larger trade.

Leverage is shown as a ratio, for example 1:100. Note that leverage amplifies both potential profits and losses alike.

Let’s say you decide to buy 100,000 EUR and sell USD at a rate of 1.4100. Your account leverage is 1:200.

Do you need 100,000 US dollars to open the trade? No!

With a leverage of 1:200 you will need to put down only 1/200 of the deal size as the margin, which works out to $500.

Calculate the margin: Leverage 1:200 Deal size = 100,000 Divide 100,000 by 200= 500 Margin = $500 This is the amount that will be used to cover your potential losses.

In other words, the margin is the actual amount that you are risking to lose if the trade goes against you.

Stop Loss

When you place a trade in your trading platform, you also specify two values called ‘Stop loss’ and Take profit’.

These values tell your broker to automatically close the trade when it reaches either the desired profit or an area beyond which the loss will be too much.

For example, let us say that you cannot afford a loss of more than 20 pips.

Since there is always a chance of losing a trade, you would want to set the trade to automatically exit when it goes 20 pips against the desired direction.

So, you specify a certain price as Stop loss (SL), reaching which the trade will be closed automatically.

You have to set a stop loss to limit the losses.

Take Profit

Similarly, you set Take profit (TP) value to close the trade automatically, when the trade reaches a certain point in the desired direction.

For example, you may want to specify a Take profit of 20 pips after which you want the trade to be closed automatically.

Since the price may reverse at any time, You specify a Take profit value to take the profit automatically before the price moves in the opposite direction.

The ratio of the amount of take profit pips to the amount of Stop loss pips is popularly known as the risk to reward ratio.

Let us see a detailed example. You predict that the price of EUR/USD will go up.

You decide to take advantage of it to get some profit.

So, you would want to buy EUR/USD. And you see the Ask price as 1.1345. You decide to take profit when the pair goes up by 20 pips.

Similarly, you want to exit out of the trade when it goes down by 20 pips.

So, you will place the order with the following values:

Take profit: 1.1365
Stop Loss: 1.1325

Note that here our risk to reward ratio is 1:1.

Forex Trading Terms Types of Orders

There are various types of orders depending on how you enter and exit a trade.

Here, we are going to look at the most important types of orders supported by leading brokers.

Market Order

The example order, we looked to understand the stop loss and take profit was a market order.

If you instantly enter the market at the best available price, it is called a market order.

It is also known as instant execution order.

Limit Entry Order

If you buy below the market price or sell above the market price, it is called as a limit entry order.

Here the system will not execute the order immediately, but sometime in the near future when the currency pair reaches a desired price.

Since the order is pending until the desired price is reached, it is also known as a pending order.

(There is another type of pending order called ‘Stop entry order’ and we will cover that next).

The advantage of a pending order is that you don’t have to sit in front of your computer and keep watching the chart until the market reaches the desired price.

You can just place a pending order so that the system will automatically execute the order when the price is reached.

There are two types of limit orders:
Buy Limit: Buying below the market price.
Sell Limit: Selling above the market price.

Let us look at an example for buy limit.

Assume that the current price of USD/JPY is 111.25.

You don’t want to buy it right away, but you want to wait until the price goes down to 111.15.

You predict that the price will rise again after it goes down to 111.15.

So, you place a buy limit order and set the trade to execute when the price reaches 111.15.

Sell limit is similar.

Let us say that the current price of GBP/USD is 1.2811.

You don’t want to go short right away, but you want to wait until the price goes up to
reach 1.2825.

According to your analysis, the price may come down again with a quick bearish trend after it
hits 1.2825.

So, you place a sell limit order at 1.2825.

Use sell stop order to enter trades

This is also a pending order, but it is the exact opposite of the limit entry order.

If you buy above the market price or sell below the market price, it is called as a
stop entry order.

The stop entry order also has two types:
Buy Stop: Buying above the market price.
Sell Stop: Selling below the market price.

In other words, you execute a buy stop order when you believe that after the price goes up to a certain level, It will continue in the upward direction.

In the same way, you would place a sell stop order when you believe that after the price goes down to a certain level, it will continue in the downward direction.

Read the hole article about “How to open a FOREX account” HERE

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