Investing 101: Breaking Down Forex Jargon
Updated: Feb 9
Following on from my last article on Forex which you can access here, in which I explained that, in my opinion, the financial markets are in no way a place to make money quickly, today’s follow-up article will provide some tips on how you can get started trading foreign exchange (Forex).
Firstly, let me introduce you to some common vocabulary in the foreign exchange world.
A change in the exchange rate for currency pairs is measured using pips. A pip is usually the last decimal place of a price quote. For example, let’s say you place a “buy” order on the euro versus the dollar at a price 1.18300. Through the works of great technical analysis, combined with an in-depth fundamental understanding of economic news and a pinch of luck, the euro breaks out above its long rally and the price reaches 1.19500. Congratulations, you have scored yourself 1200 pips, and have gained financially!
Selling one currency pair versus another is referred to as entering a short position. For example, imagine the following scenario: “Hey dude, did you hear about the new debate on fiscal stimulus in the U.S.! If they print more U.S. dollars, investors might pull out their money due to fear of inflation. I think I will short the U.S. dollar versus gold, since gold tends to go up during inflation!”
Similarly, if you are buying one currency versus another, you are entering a long position. Again, consider the following hypothetical example: “I’ve been doing this analysis on the Swiss Franc versus the Australian Dollar. It broke above the resistance level and created a typical bull flag pattern. I think I will go long!”
Currency pairs are referred to in abbreviations rather than full terms. The first currency in a currency pair is the one you are either buying or selling versus the second currency. Here are just some examples:
- Short USD/CAD means you are selling the U.S. dollar and buying the Canadian dollar.
- Long EUR/JPY means you are buying the euro and selling the Japanese yen.
Spread is the difference between the buy and a sell price. For example, if you execute a “sale” order and it hits your target price (take-profit; TP), but there is no buyer available at that price, your order will be fulfilled at the closest buyer’s bid price. Spreads often reflect the liquidity in the market. A high liquidity means lots of buyers and sellers, so orders can be fulfilled readily at any given price. Since the U.S. dollar is the most traded currency in the world, liquidity in currency pairs involving the U.S. dollar tends to be good.
Tip: Spreads between 10p.m. and 12a.m. (GMT) drastically increase for some currency pairs. If your stop loss is too tight it might get triggered without actually hitting the price.
Another key term worth mentioning in this article is volatility. This refers to how drastically the market’s price changes. The forex market is very volatile. The more traders there are in the market at any given time, the more liquid the market, and thus, the market moves in smaller increments. Consequently, currency pairs that do not involve the U.S. dollar (known as exotic pairs) are much more volatile because they are traded less. As a beginner, you might want to avoid these.
Stop Loss (SL) is a market order you place to limit a loss. For instance, if the price reaches a level that invalidates your analysis, an SL order automatically closes it for you. By any means, you don’t have to set an SL, but for beginners, this is considered trading suicide. Do not let your trades run wild when you cannot afford the time or dedication to stare at charts all day. Set boundaries which limit how much of your capital you are willing to lose for a particular trade.
Take Profit (TP) is a market order which automatically closes the trade and secures your profit once it reaches a set price quota. The rationale is identical to an SL, but instead, rather than losing money, you are losing profit which you failed to secure by not placing your TP. You can always modify these at any point, so there is no pressure to take small profits when you see the price move rapidly in your direction, but it is better to be safe than sorry!
So, how can you get started?
First and foremost, as a retail trader, you will need to find a broker. Prior to the emergence of brokerage firms, independent trading was almost impossible due to the high costs associated with buying/selling currencies. Now, brokerages conduct these transactions on behalf of retail traders, allowing us to participate in the markets. In turn, they charge fees for these transactions which normally occur in a form of a spread. Some brokers offer better spreads than others, some have hidden fees, and some don’t allow individuals to keep trades open overnight or over the weekend. Therefore, it’s important to do some research and find the best one for you. The most important thing is that most brokers offer demo accounts, which provide you with fake money to practice on. These are absolutely crucial, since they provide you with the ability to trade in real markets without losing any money. Once you can consistently generate profits on your demo account, this is when you should start investing small amounts of real money. Many traders fail to practice first, and thus lose all of their savings before they even get started. Remember, trading should not turn into gambling - it is skill-based to a degree.
After you decide on your broker, you then should find a platform where you can do your analysis and execute your trades. Most people use MT4, which is readily available on any smartphone or computer. Personally, I use tradingview.com to do my analysis, and MT4 to execute my trades. Tradingview is a free platform that offers a comprehensive number of tools for technical analysis. Each of these tools has its own purpose and it can become quite overwhelming to be exposed to all of it at once – especially as a novice.
For next time
My articles to follow this will focus on technical analysis and go over the basic price action movements to assist you in your trading. For now, try to familiarize yourself with some basic concepts in forex, find a broker, and play around with various platforms. I wish you the best of luck - dedication and resilience is key – and if you have any questions drop them in the comments below!
The Student Investor is not a registered investment, legal or tax advisor or broker/dealer. All opinions expressed by The Student Investor are from the personal research of the author, and are written for educational purposes only. Although best efforts are made to ensure that all information is accurate and up-to-date, occasionally unintended errors and misprints may occur. Please note that the value of your investment can go up or down, and The Student Investor takes no responsibility for any decisions made by readers.