Mastering Forex Trading: Essential Key Terms Every Beginner Must Know for Success
Trading is the most popular method of generating wealth, but do you actually know the key terms that drive the market? To navigate the complexities of trading and be successful at it, it's crucial that you know the key terminologies that form the backbone of every transaction. We'll take you through the core terms you ought to know in this guide, because how you trade is just as important as where you trade.
What are Currency Pairs
Forex currencies are always traded in pairs, and a currency is exchanged for another. The initial currency in a pair is called the base currency, and the second one is called the quote currency. For example, in the AUD/USD, the base currency is the US dollar (USD) and the quote currency is the Australian dollar (AUD). The quote currency is the amount of it that will be needed to buy one unit of the base currency. So, if the AUD/USD rate is 0.6300, one Australian dollar is equal to 0.63 US dollars.
Currency pairs are typically quoted to four decimal places, with the exception of Japanese yen pairs, which are quoted to two decimal places.
"When you trade currency pairs, you are essentially speculating whether the base currency will rise or fall against the quoted currency. If you believe that the base currency will strengthen, you would buy the pair, and if you think it will weaken, you would sell the pair”
Pip & Lot Size
A pip, or "percentage in point," is the smallest price change in the foreign exchange market. It is the fourth decimal in most currency pairs, such as EUR/USD. If the EUR/USD exchange rate rises from 1.1800 to 1.1801, for example, that's a one-pip move.
Pips are very important in forex trading since they determine the potential profit or loss on a transaction. A one-pip movement can be zero, but in trading lots, even a minor movement in price can represent enormous profits or losses.
Lot size is the amount of currency which will be traded on one trade. The standard lot size in forex trading is 100,000 of the base currency. The majority of brokers, however, also offer smaller lot sizes for those traders with smaller account sizes. For example: Standard Lot of 100,000 of the base currency, Mini Lot: 10,000 of the base currency and finally a Micro Lot: 1,000 of the base currency.
Bid & Ask Price
The ask price is the price at which you can buy a currency pair, and the bid price is the price at which you can sell it. The spread is the difference between the two.The ask price is always higher than the bid price, and this spread is where forex brokers make their profits. When you buy long, you pay the ask price, and when you sell, you get the bid price. The narrower the spread, the lower the cost to trade. Conversely, the broader the spread, the more expensive trading becomes, and it eats into your profit margin in the long term. Additionally, a widening spread could mean increasing volatility or diminishing liquidity, and that impacts your trading strategy and risk management.
Therefore, it's important to have a proper understanding of trading and know the important terms and perform a detailed analysis, particularly if you're a new trader or trading with limited money.
Pip & Lot Size
A pip, or "percentage in point," is the smallest price change in the foreign exchange market. It is the fourth decimal in most currency pairs, such as EUR/USD. If the EUR/USD exchange rate rises from 1.1800 to 1.1801, for example, that's a one-pip move.
Pips are very important in forex trading since they determine the potential profit or loss on a transaction. A one-pip movement can be zero, but in trading lots, even a minor movement in price can represent enormous profits or losses.
Lot size is the amount of currency which will be traded on one trade. The standard lot size in forex trading is 100,000 of the base currency. The majority of brokers, however, also offer smaller lot sizes for those traders with smaller account sizes. For example: Standard Lot of 100,000 of the base currency, Mini Lot: 10,000 of the base currency and finally a Micro Lot: 1,000 of the base currency.
“Smaller lot sizes allow traders to manage their risk more effectively, especially when starting out or testing new strategies. This helps traders control their potential losses while gaining experience and confidence in the market.”
Leverage & Margin
Leverage is an attribute that allows the traders to maintain a larger position with relatively lesser capital. It does so by using borrowed capital from the broker to amplify the scale of a trade. As an example, a trader holding $1,000 in their account using leverage 50:1 can maintain a position worth $50,000. This attribute has the capability to increase both possible profits and losses. Although it can exaggerate profits, it also has a greater potential for large losses if the trade is against the trader.
Always be careful and have a sound strategy when utilizing this tool. Margin is the capital required to initiate and maintain a leveraged position. It can be applied as security money or collateral against the broker. The margin requirement will be determined by the amount of leverage utilized and the size of position. Normally, a higher level of leverage will have a lower margin requirement, but with higher risk.
When trading with leverage, traders must maintain a minimum margin level in their account. If the account balance falls below the required margin due to adverse price movements, the broker may initiate a margin call, requiring the trader to deposit additional funds or close the position to reduce the risk of further losses.
"A beginner should have good stop-loss orders and adhering to the position sizing rules are extremely crucial while trading with leverage in order to avoid any losses."
Now that you have learned about the tools and the key terms, click to learn about the trading analysis.
