Currency Trading Terms
Spot Forex or FX Market
A Spot forex market is a market for immediate transactions as opposed to an agreement to make a transaction some time in the future (eg. futures).It is often referred to as the “interbank” market. A spot foreign exchange transaction is a contract to exchange two currencies, typically in two business days), at an exchange rate agreed today. Spot Forex allows the trader high liquidity, strong profit potential from continual market fluctuations by buying a specific currency when it is weaker and selling it when it is stronger, and the continual pairing of strong currencies against weak ones. All the futures trading offered in RapidSP use the SPOT Forex data.
The price of a currency (foreign exchange rate) is always given in terms of another currency. That is why you will hear that currencies trade in “pairs.” In the Interbank market, the currency pairs are standardized; for example, euros in terms of dollars, dollars in terms of Japanese Yen, and not the other way around. An example can make this clearer. Let’s say that the price of the euro versus the dollar is:
EUR/USD = 1.2125
This means that 1-euro is equal to 1.2125 US Dollars. The currency to the left of the forward slash (“/”) is called the “base currency” and the one on the right is called the “quote currency” (also called the “counter currency”). Currency quotes are thus given for the base currency in terms of the quote currency; i.e., euros in terms of dollars – 1 euro is equal to 1.2125 dollars. Day traders new to currencies might be confused trying to interpret the quote above mathematically; in other words, thinking that EUR/USD means euros per dollar (it does not – it actually means dollars per euro!!!). This is a mistake that is quickly avoided when you simply memorize to add a one (1) in front of the EUR/USD and understand that the number on the right (1.2125), beside the second currency, is the number of units of the second currency; in other words, the quote EUR/USD = 1.2125 means that 1 EUR is equal to 1.2125 USD.
There are a few exceptions to prices with four decimal places; for example, the quote of the dollar versus the yen is taken only to two decimal places. Let’s see what this means?
USD/JPY = 107.65
This means that (reading from left to right) 1 USD is equal to 107.65 JPY (Japanese Yen).
When day trading currencies, the term PIP is used often. A pip, which stands for “price interest point,” represents the smallest fluctuation in the price of a currency. This is similar to the concept of “tick” for stocks. So how much is a pip worth? The value of a pip depends on the size of the contract (or lot) that is traded. Most online forex brokers offer regular contracts (or lot) sizes of 100,000 units of the base currency. With this figure in mind, we could determine what a pip is worth. Let’s take the quote example above of EUR/USD = 1.2125. If:
1 euro equals 1.2125 dollars, then 1 lot (or contract) of 100,000 euros should be worth 121,250 dollars and a fluctuation of 0.0001 (1 pip) should be worth 100,000 x 0.0001 = 10 dollars. Therefore, every time the price of the euro versus the dollar fluctuates by one pip, the value of each contract changes by 10 dollars. For currencies that are quoted in terms of dollars (that is, when the USD is the quote currency), the PIP value is fixed (10 dollars if the currency is quoted to the fourth decimal place). This is what is called a “static pip value” because the value is constant relative to the dollar. Major currencies (other than the EUR/USD) with a static pip values are the GPB/USD (British Pound versus the US Dollar – also known as “cable”) and the AUD/USD (Australian Dollar versus the US Dollar – also know as “aussie”).
Are there currencies with a “variable pip value?” Yes there are. A currency with a variable pip value is one that has the dollar as the base currency. The major currencies or “majors” with a variable pip value are the USD/JPY, the USD/CHF (US Dollar versus the Swiss Franc), and the USD/CAD (US Dollar versus the Canadian Dollar). Using the earlier example of the USD/JPY = 107.65, if:
1 USD equals 107.65 yen, then 1 lot of 100,000 dollars should be worth 10,765,000 yen and one pip should be worth 100,000 x 0.01 = 1000 yen. If we want to turn this value into dollars, we have to divide by the current exchange rate (107.65 yen per dollar). Thus, 1000 / 107.65 = 9.29 dollars. We automatically conclude that the value of one pip in the dollar-yen currency pair (in terms of dollars) will always vary as the exchange rate varies.
Since currencies are traded in lots (or contracts) and each standard lot is worth 100,000 units of the base currency, In currency trading, the margin requirement can be anywhere from 1,000 (1%) to 2,000 (2%) units of the base currency per lot depending on the broker. This represents a leverage of 50 to 1 to 100 to 1. HUGE!!! This is one of the advantages currencies have over stocks for day trading purposes. Even though a 50 to 1 margin is excessive for most trading styles, it is available to the trader nevertheless. The trader is free to decide what amount of leverage to use depending on the nature of the day trading strategy that he is using, his available trading capital, and the risk he is willing to take on each transaction.
Mini forex accounts, also known as forex minis, can be used by day traders who do not have sufficient capital to trade regular accounts with contract sizes of 100,000 or more. Mini accounts typically offer contract sizes of 10,000 instead of 100,000 and margin requirements per contract of $50 or more (instead of the $1,000 to $2,000 per contract required in regular accounts). Consequently, mini forex trading accounts have account minimums that are much lower than that of regular accounts (as low as a few hundred dollars or less in some cases!). This allows small investors to day trade currencies using the same platform as regular forex traders. Some currency brokers offer a wider spread for mini accounts and some might charge a transaction per trade. In reality, if the mini contract is 10,000 units of the base currency, then all of the calculations are simply a tenth of what they would be for regular accounts with 100,000 lot sizes; for example, the value of 1 pip for the EUR/USD on a mini contract will be 1 dollar instead of 10.
Bid and Ask
For currencies, like for stocks, there is not just one price to worry about. A quote is given as a bid price and and ask price. So if we are using an online day trading platform, we might see the following for the EUR/USD currency pair:
Bid 1.2105 Ask 1.2109
This means that an institution (let’s say a bank) is trying to buy (Bid) the euro versus the dollar at 1.2105 and another institution is offering to sell euros versus the dollar (Ask) at 1.2109. As currency day traders, we can buy from the bank that is selling at 1.2109 or sell to the bank that is buying at 1.2105. (In general, systems that allow a trader to post bid and ask prices for currencies do not have enough liquidity at the moment, so traders have to buy at the ask and sell at the bid.
The margin (amount of money you need to deposit with your broker to trade a particular contract) requirement varies from broker to broker. Typically it is about 1/100th of the lot size. For example to trade one standard contract of EURUSD you will need to deposit about $1200 with your broker.