Quickly Understand The Forex Market & Basic Terminology With This No-Nonsense Training That Brings You Up To Speed In A Flash
The Foreign Exchange Currency Market has many names: “Forex”, “Retail Forex”, “FX”, “Spot FX” or “Spot Markets”.
The Foreign Exchange Market was established in 1971 with the abolishment of the fixed currency exchanges. Since then, currencies have become valued at floating rates determined by supply and demand. The exchange rates are in constant flux.
So, essentially, Forex is the relative value of one currency versus another.
The easiest way to understand Forex is to forget about charts and graphs and focus on something “real world”. Most people have had some type of real world experience with Foreign Exchange if they have ever tried to purchase something not in the currency that is their own.
For example, if you’ve ever visited a foreign country or tried to purchase something online from a different country, you’ve already participated in the Foreign Exchange Market.
So, if you are from the USA and plan to visit Switzerland, you are going to need to convert some US dollars into Swiss Francs in order to have some spending money on your trip. You will exchange your dollars for Swiss francs based on the exchange rate at the time you are making the transaction.
Or, you are purchasing something from Europe from the USA and the price is shown in Euro Dollars. You’ll have to figure out the exchange rate and convert the price into US dollars to understand how much you’ll be spending.
On this small scale, this is all pretty simple to understand. Now, expand this exchange of one currency value for another on a global scale, and you’ll start to see how HUGE the Forex market really is.
The Forex Market operates in a global network where governments, banks, institutions and individuals trade openly. Prices are shared across the global network for everyone to see. And the market is only getting bigger.
Forex grew steadily throughout the 1980’s, but saw a huge increase during the 1990’s due to technological advances such as the Internet. Since then, the Forex Market grew from a trading volume of $50 Billion a day to between 3 and 5 TRILLION a day worldwide.
Compare this to the New York Stock Exchange with a daily trading volume of $25-$30 Billion a day… and you can see just how HUGE the Forex market really is.
In fact, Forex is by far the largest liquid financial market in the world today.
So, what does this mean for you in terms of speculating the Forex market for profit?
From a trading, money making and wealth creation standpoint, what you want to do is:
You see, it's pretty simple. Buy or sell a currency at one rate, and then sell or buy it back at a more favorable rate… and the difference is profit.
Basic Terminology Of The Forex Market
There are a few terms I want to go over as you will see them mentioned over and over again. While this may seem very basic for some, I want to make sure everyone is on the same page as we move forward.
Broker: A Forex broker is a firm or individual who offers trading services to people who want to buy and sell currencies. A Forex broker generally provides a trading platform to execute trades online, making it possible for individuals to participate in the Forex market. In order to participate in the Forex market, you will need to open a Forex broker account.
Currency Pair: The currency of a country is actually what is being traded on the Forex Market. Currencies are traded in pairs, and it is best to think of currency pairs as a single trading unit.
The price of the currency pair is a direct reflection of what the market thinks about a country (or group of countries) and its economic state versus another country (or group of countries) and its economic state.
For example, the EURUSD reflects what the market thinks about the European economy versus the economy of the United States.
The first currency is called the BASE currency and the second currency is called the QUOTE currency. For example, in the EURUSD currency pair the Euro Dollar is the Base Currency and the US Dollar is the Quote Currency.
When you BUY a currency pair, you are buying the Base currency and selling the quote currency. (For example, if you BUY the EURUSD, you are buying the Euro Dollar and selling the US Dollar).
When you SELL a currency pair, you are selling the Base currency and buying the quote currency. (For example, if you SELL the EURUSD, you are selling the Euro Dollar and buying the US Dollar).
Pip: A “PIP”, Price Interest Point, is the basic unit in Forex trading that measures the change in value of a currency pair. Basically, a pip is the smallest amount by which changes in a currency pair value can be measured. Most currency pairs have 4 decimal spaces, while some (like the JPY pairs) have 2 decimal spaces.
For a currency with a 4 digit price, the PIP is represented by the fourth decimal space.
For example, if the price of the GBPUSD is 1.3536, the 6 at the end represents the PIP.
- If price moves from 1.3536 to 1.3537, that is a 1 pip increase.
- If price moves from 1.3536 to 1.3535, that is a 1 pip decrease.
IMPORTANT: A lot of brokers show 5 decimals. The 5th decimal is not a FULL PIP, but rather a fraction of a pip, called a pipette.
For example, if the price of the GBPUSD is represented on your broker platform as 1.35361, the pip representation is 6.1 pips. (6 full pips and 1 pipette).
- In order to have a full pip increase, price would have to move to 1.35371
- For a full pip decrease, price would have to move to 1.35351
However, for a currency with a 2 digit price, the PIP is represented by the second decimal space.
For example, if the price of the GBPJPY is 172.11, the 1 at the end represents the PIP.
- If price moves from 172.11 to 172.12, that is a 1 pip increase
- If price moves from 172.11 to 172.10, that is a 1 pip decrease
IMPORTANT: A lot of brokers show 3 decimals. The 3rd decimal is not a FULL PIP, but rather a fraction of a pip, called a pipette.
For example, if the price of the GBPJPY is represented on your broker platform as 172.119, the pip representation is 1.9 pips. (1 full pips and 9 pipettes).
- In order to have a full pip increase, price would have to move to 172.129
- For a full pip decrease, price would have to move to 172.109
Spread: Forex operates in an auction marketplace. There is a buyer and a seller for each trade placed. The price paid by the buyer is different from the price received by the seller.
- The BUYER is called the “Ask” price
- The SELLER is called the “Bid” price
- SPREAD is the difference between the Bid and Ask prices
The Spread is where the broker makes its money on every trade you place. In other words, the spread is the cost of placing a trade with your broker, and how they make their money. Instead of charging commissions for each trade, they profit from the spread.
Each currency pair has different spread prices, so it is important to pay attention to the spread so you can control your trading costs.
Lots: Currency pairs are traded in lots. There are 4 lot sizes to choose from:
When you place a trade, you will have to stipulate the lot size you want to use. The lot size you use determines the risk you are willing to take on the trade.
For example, if you place a trade with a 1 standard lot and a stop loss size of 20 pips, you are willing to risk $200 on the trade (1 Standard Lot = $10 a pip and $10 x 20 pips = $200).
In order to have the most flexibility with your lot sizing, I recommend using a Forex broker account that allows Micro lots. This way you can fine tune your risk as much as possible. For example, using a lot size of 1.23 would mean you are willing to risk around $12.30 per pip.
I personally have never used Nano Lots, so I cannot comment on the value of using them. In my experience, Mini Lots are flexible enough to provide the correct lot allocation, so that is what I recommend.
As you can see, understanding the Forex Market and basic terminology is not all that hard. And participating in the market can be an easy to learn and simple to trade process as well.