The Language of Forex: Understanding Foreign Exchange Terms

Dec 19, 2010
David J. Shestokas

Dollars, Euros, Pounds, Rubles - Forex Trading

Many are becoming interested in trading in the foreign exchange, or Forex, market. Forex has its own language which any potential trader must know.

Trading foreign currencies effectively requires skill and knowledge. The very first order of business is being able to study materials and not get lost in the terminology. This article describes some of the most commonly used terms in the business of foreign exchange.

Forex

Forex, FX, or foreign exchange, is used to refer to the market in which trades are conducted by buying the money of one country using the money of another. There is not actually a single market, but groups of markets around the world, and a given trade can be executed from Australia to New York, 24 hours a day, 5.5 days per week.

Currency

"Currency" is a country’s money. The US Dollar is the currency of the United States. The British pound is the currency of Great Britain. There are the New Zealand, Australian and Canadian dollars. When one travels in foreign countries, the currency of one’s home country needs to be exchanged for the local currency to buy things.

Exchange Rate

The exchange rate is the value of a country’s money in relation to that of another country. If one were traveling in Europe, one would need Euros to buy things. To buy a Euro as this is written, costs about $1.32 in US Dollars. That would be the exchange rate.

Pip

The value of a particular currency involved in a Forex trade is typically expressed to four digits beyond the decimal point. In a typical Forex price quote, it might take 1.3343 US dollars to buy one Euro. The last digit is the pip. In this case, three pips.

Retail Trader

An individual who places orders to buy or sell foreign currency on behalf of himself in a Forex market is known as a retail trader.

Broker or Dealer

The party that brings buyers of currency together with sellers.

Broker or Dealer Platform

A platform is provided by the party that puts a buyer and seller of a currency pair together to complete a transaction. This is generally the internet site or software that a Retail Trader uses to conduct business on the Forex market. The platform includes a variety of buying/selling tools and information about the market. It allows the trader to see current and historical prices and to place orders.

Currency Pair

Trades on the Forex market are always made in terms of the currency of one country versus the currency of another. As an example, the currency pair of EUR/USD consists of the Euro and US Dollar.

Base Currency: The first currency of the pair is the base currency. In EUR/USD, Euros are the base currency.
Quote or Counter Currency: The second currency of a pair is the quote or counter currency. It is the quote currency that is used to express the price of a transaction.

In the example of EUR/USD, the price of 1.3340 – 1.3343 means that a seller of Euros would receive $1.3340 for each Euro sold. A buyer of Euros would pay $1.3343 for each Euro bought.

Spread

Prices of currency pairs are quoted as “bid” and “ask”. The “bid” price of a currency pair is the sale of the base currency quoted in an amount of the quote currency. The “ask” price of a currency pair is the purchase of the base currency in an amount of the quote currency. The difference between the “bid” and “ask” is known as the spread. EUR/USD 1.3340 – 1.3343 has a spread of .0003 or 3 pips. The spread is often the equivalent of a broker’s commission.

Leverage

Leverage is a multiple of the money a trader has on deposit with a broker that the broker will allow a trader to use in conducting a transaction. Current regulations limit US retail traders to using a leverage of 50 to 1. This means that a retail trader with a $1,000 deposit with his broker may be able to conduct trades with values of up to $50,000. It is this leverage range that is one of the great attractions of trading in the Forex market.

Forex Fundamental Analysis

A fundamental analysis of a particular currency in the Forex market consists of evaluating outside factors that affect the value of that currency. These factors include: interest rates, inflation and economic data of the currency’s country. Changes in these factors can cause movement in a currency’s value versus other currencies.

Forex Technical Analysis

Forex trading involves analyzing a great deal of data available about price movements. Technical analysis is using historical price movement data in an effort to predict price movements in the future. There are numerous technical analysis tools and trading signals employed in an effort to determine the best prices to buy or sell a given currency.

Forex Regulation

Each country has its own regulatory body related to the Forex market in the United States there are two principle sources of Forex regulation:

The National Futures Association (NFA) The NFA the self-regulatory organization of the US futures industry. It implements Forex regulations to protect the integrity of the market. Every futures or Forex broker operating in the US must be a member.
The Commodity Futures Trading Commission (CFTC) The CFTC was created by Congress in 1974 as an independent agency empowered to issue Forex regulations for the United States.