When you first hit the markets it likely that you will come across a lot of jargon and unfamiliar terminology that you don’t quite yet understand. Don’t worry, this happens to all of us.
However, it is important that you get to grips with the industry lingo as quickly as possible so that you can understand what is going on in front of you.
Below we will cover the key terms that you need to know before you start forex trading.
Bid and ask
When you look at any of the currency pairs you will always see two different exchange rates at any one given time. This is the bid price and the ask price.
This can often be slightly for new traders, but there is no need to be.
The bid = the highest price that somebody is willing to pay for the currency
The ask = the lowest price that somebody is willing to sell the currency for
Naturally, the bid price is always lower than the asking price as people are trying to get the best value for their trade. However, when these two prices meet in the middle, that is the moment when a transaction occurs.
Note: You may sometimes see the ask price being referred to as the “offer price”, depending on your brokerage.
The spread is simply the difference between the bid price and the ask price and is usually measured in pips.
It is often a key indicator of the liquidity of the market – the smaller the spread, the more liquid the market is, and vice versa.
For example, the spread on one of the Major currency pairs is typically very low due to its huge trading volume when compared to the spread on a lightly traded Exotic currency pair.
The spread can often widen during times of increased volatility and uncertainty in the market.
This can discourage traders from entering new positions as it becomes more expensive and the likelihood of a profitable trade diminishes as the spread increases.
When we are using a brokerage, the spread is typically the area where they will make their profit.
Here is an example of a bid/ask spread.
From this we can calculate the spread in pips by deducting the ask price from the bid price.
Spread = 13033 pips – 13031 pips = 2 pips
Competition between brokers is fierce. Having a low spread is one of the main fronts that the brokerages compete on. You will often see them quote their low spread prices in their advertisements to try and attract new traders.
The spread quoted in their advertisements is usually for the EUR/USD as this is the most heavily traded pair on the market and therefore tends to have the lowest spread.
This is the main reason for brokers introducing the 5th decimal place as it gives them more opportunity to compete. For example:
Spread = 11174.2 pips – 11173.4 pips = 0.8 pips
Slippage is what occurs when you place an order in the market at once price but it eventually executes at a different price.
This is due to low execution speeds and usually occurs during times of high volatility when the price is moving around a lot.
It’s a relatively common thing to happen to you as a trader and there is normally no need for concern. Sometimes you will get slippage in your favour and you will receive a better price, and other times it may go the other way.
If you are trading the Majors and currency pair with a lot of trading volume and considerable market depth, then slippage usually isn’t an issue.
Margin is what you need in your trading account in order to access leverage. It can sometimes be easier to look at margin as if it were collateral or a deposit for a loan.
In order to access leverage you must have a margin account, which is different to standard brokerage account, however, the vast majority of trading accounts in forex are margin accounts.
If you are trading using a margin account then “margin” is the word used to refer to balance that you have in your account.
Let’s say you want to enter a £1,000 position with a 5:1 leverage
£1,000/5 = £200
In this instance, your required margin would be £200. In other words, you need £200 in your account in order for you to execute this trade.
One thing to keep in mind is the currency that your account is kept in. More often than not, this is the currency that you will have loaded your account with originally.
When you are trading pairs that do not include your default account currency then you will usually have to exchange it to the base currency of the currency pair that you are trading. From that point you can execute your trade as normal.
Any profits and losses are typically exchanged back to your account currency, too. This is normally not a problem, however some brokerages may take a small fee for this which may eat into your bottom line over a long period of time.