What is Forex?
The world runs on money. The global economy – and our very way of living – depends on the act of money changing hands. Not just in our country, but all over the world. The value of money in one country is largely based on the value of money in other countries.
Forex History, Currency Pairs, What is Forex…
Forex is a term that refers to foreign exchange, which is the market of trading one country’s currency for another. When you’re in another country, trading your country’s currency for the currency of the country you are visiting is what the forex market is all about. In order to trade your U.S. dollars for another, for example – the Japanese yen, the foreign exchange rate between the two countries must be established.
Forex history begins long after the establishment of coins as a method of purchasing items. Often, trade outside of a country still relied on bartering, because the value of one currency was not always agreed upon by another country. Paper money in the form of IOUs was printed against the value of metals, such as gold, in the middle ages. The Knights Templar are said to have used this method when moving funds, forming the basis of our modernday banking system. Until World War I, most currencies in central banks were supported by the physical possession of gold. However, it became acceptable to print money without this backing, sometimes with disastrous results. The Bretton Woods agreement of 1944 was created to help stabilize local currencies and encourage fair exchange between countries.
Comparing one currency with another is the heart of forex. Currency pairs – literally a pair of currencies – are compared with each other. For example, the U.S. dollar and the Euro… One currency has a particular value when traded for another currency. The currency value of each country is, in large part, based on the value of the countries that regularly trade with it, or have similar economies. How this is determined is a rather complex process, and will be discussed in another article.
Currencies are traded without a central exchange, which is different from how stocks and futures are traded. The forex market is operated is Europe, Asia and the U.S. in different shifts, so currencies are constantly traded 24 hours a day. Foreign exchange trading between individual banks, banks and forex brokers, and brokers and individuals, is conducted thousands of times every day. No single entity has the capability of influencing the market – at least for very long. This is truly a democratic form of trading.
Glossary of Forex (Foreign Exchange) Terminology
- Appreciation – A currency is said to ‘appreciate ‘ when it strengthens in price in response to market
- Ask Rate – The rate at which a financial instrument if offered for sale (as in bid/ask spread).
- Asset Allocation – Investment practice that divides funds among different markets to achieve
diversification for risk management purposes and/or expected return consistent with an investor’s
- Bar Charts – Standard bar charts are commonly used to convey price activity into an easily readable chart. Usually four elements make up a bar chart, the Open, High, Low, and Close for the trading session/time period. A price bar can represent any time frame the user wishes, from 1 minute to 1 month. The total vertical length/height of the bar represents the entire trading range for the period. The top of the bar represents the highest price of the period, and the bottom of the bar represents the lowest price of the period. The Open is represented by a small dash to the left of the bar, and the Close for the session is a small dash to the right of the bar.
- Base Currency – In general terms, the base currency is the currency in which an investor or issuer maintains its book of accounts. In the FX markets, the US Dollar is normally considered the ‘base’ currency for quotes, meaning that quotes are expressed as a unit of $1 USD per the other currency quoted in the pair. The primary exceptions to this rule are the British Pound, the Euro and the Australian Dollar.
- Bear Market – A market distinguished by declining prices.
- Bid Rate – The rate at which a trader is willing to buy a currency.
- Bid/Ask Spread – The difference between the bid and offer price, and the most widely used measure of market liquidity.
- ‘Blow your account’ – to lose all your available trading capital through poor decisions regarding the behavior of currency pairs
- Book – In a professional trading environment, a ‘book’ is the summary of a trader’s or desk’s total positions.
- Broker – An individual or firm that acts as an intermediary, putting together buyers and sellers for a fee or commission. In contrast, a ‘dealer’ commits capital and takes one side of a position, hoping to earn a spread (profit) by closing out the position in a subsequent trade with another party.
- Bull Market – A market distinguished by rising prices.
- Buying/Selling – In the Forex market currencies are always priced in pairs; therefore all trades result in the simultaneous buying of one currency and the selling of another. The objective of currency trading is to buy the currency that increases in value relative to the one you sold. If you have bought a currency and the price appreciates in value, then you must sell the currency back in order to lock in the profit.
- Candlestick Chart – A chart that indicates the trading range for the day as well as the opening and closing price. If the open price is higher than the close price, the rectangle between the open and close price is
shaded. If the close price is higher than the open price, that area of the chart is not shaded.
- Choice Market– A market with no spread. All trades buys and sells occur at that one price
- Clearing – The process of settling a trade.
- Collateral – Something given to secure a loan or as a guarantee of performance.
- Commission – A transaction fee charged by a broker.
- Contract – The standard unit of trading.
- Contract (Unit or Lot) – The standard unit of trading on certain exchanges.
- Counterparty – One of the participants in a financial transaction.
- Cross Rates – The exchange rate between two currencies expressed as the ratio of two foreign exchange rates that are both expressed in terms of a third currency. Foreign exchange rate between two currencies other than the U.S. dollar, the currency in which most exchanges are usually quoted. Currency – Any form of money issued by a government or central bank and used as legal tender and a basis for trade.
- Currency Risk – the probability of an adverse change in exchange rates.
- Day Trading – Refers to positions which are opened and closed on the same trading day.
- Dealer – An individual who acts as a principal or counterpart to a transaction. Principals take one side of a position, hoping to earn a spread (profit) by closing out the position in a subsequent trade with another party. In contrast, a broker is an individual or firm that acts as an intermediary, putting together buyers and sellers for a fee or commission.
- Deficit – A negative balance of trade or payments.
- Delivery – An FX trade where both sides make and take actual delivery of the currencies traded.
- Depreciation – A fall in the value of a currency due to market forces.
- Derivative – A contract that changes in value in relation to the price movements of a related or underlying security, future or other physical instrument. An Option is the most common a 4eds derivative instrument.
- Devaluation – The deliberate downward adjustment of a currency’s price, normally by official announcement.
- Economic Indicator – Economic indicators such as GDP, foreign investment, and the trade balance reflect the general health of an economy, and are therefore responsible for the underlying shifts in supply and demand for that currency.
- End Of Day Order (EOD) – An order to buy or sell at a specified price. This order remains open until the end of the trading day which is typically 5PM ET.
- Fixed Exchange Rate– Official rate set by monetary authorities for one or more currencies
- Floating Exchange Rates – Floating exchange rates refer to the value of a currency as decided by supply and demand
- Flat/square – Dealer jargon used to describe a position that has been completely reversed, e.g. you bought $500,000 then sold $500,000, thereby creating a neutral (flat) position.
- Foreign Exchange – (Forex, FX) is the simultaneous buying of one currency while selling for another. This market of exchange has more buyers and sellers and daily volume than any other in the world. Taking place in the major financial institutions across the globe, the forex market is open 24-hours a day.
- Fundamental Analysis – focuses on the economic forces of supply and demand that causes price movement. The Fundamentalist studies the causes of market movement, whereas the Technician studies the effects.
- Futures Contract– An obligation to exchange a good or instrument at a set price on a future date. The primary difference between a Future and a Forward is that Futures are typically traded over an exchange (Exchange- Traded Contacts – ETC), versus forwards, which are considered Over The Counter (OTC) contracts. An OTC is any contract NOT traded on an exchange.
- Hedging – A hedging transaction is a purchase or sale of a financial product, having as its purpose the elimination of loss arising from price fluctuations. With regards to currency transactions it would protect one against fluctuations in the foreign exchange rate. (see Forward Contract)
- Inflation – An economic condition whereby prices for consumer goods rise, eroding purchasing power.
- Initial margin – The initial deposit of collateral required to enter into a position as a guarantee on future performance.
- Interbank Rates – The Foreign Exchange rates at which large international banks quote other large international banks
- Leading Indicators – Statistics that are considered to predict future economic activity.
- LIBOR – The London Inter-Bank Offered Rate. Banks use LIBOR when borrowing from another bank.
- Limit order – An order with restrictions on the maximum price to be paid or the minimum price to be received. As an example, if the current price of USD/YEN is 102.00/05, then a limit order to buy USD would be at a price below 102. (ie 101.50)
- Line Charts – The Line Chart connects single prices for a selected time period.
- Liquidity – The ability of a market to accept large transaction with minimal to no impact on price stability.
- Liquidation – The closing of an existing position through the execution of an offsetting transaction.
- Long position – A position that appreciates in value if market prices increase. When one buys a currency, their position is long.
- Margin – The required equity that an investor must deposit to collateralize a position.
- Margin Deposit – The margin deposit is not a down payment on a purchase of equity, as many perceive margins to be in the stock markets. Rather, the margin is a performance bond, or good faith deposit, to ensure against trading losses. The margin requirement allows traders to hold a position much larger than the account value, which allow for this high leverage. In the event that funds in the account fall below margin requirements, brokerage firms will automatically close all open positions.
- Margin call – A request from a broker or dealer for additional funds or other collateral to guarantee performance on a position that has moved against the client. If the equity balance in your account falls below the margin requirement, a margin call will be generated. In the event that an account exceeds its maximum allowable leverage, ALL open positions are liquidated immediately, regardless of the size or the nature of positions held within the account.
- Market Maker – A dealer who regularly quotes both bid and ask prices and is ready to make a two-sided market for any financial instrument.
- Market Risk – Exposure to changes in market prices.
- Maturity – The date for settlement or expiry of a financial instrument
- Narrow Market – occurs when there is light trading and greater fluctuations in prices relative to volume. This is often interchanged for THIN MARKET.
- Offer – The rate at which a dealer is willing to sell a currency.
- Offsetting transaction – A trade with which serves to cancel or offset some or all of the market risk of an open position.
- Open order – An order that will be executed when a market moves to its designated price.
- Open position – A deal not yet reversed or settled with a physical payment.
- Overnight – A trade that remains open until the next business day.
- Pips – Digits added to or subtracted from the fourth decimal place, i.e. 0.0001. Also called Points.
- Political Risk – Exposure to changes in governmental policy which will have an adverse effect on an investor’s position.
- Point & Figure charts – The Point & Figure Chart disregards Time and focuses entirely on price activity.
- Position – The netted total holdings of a given currency.
- Premium – In the currency markets, describes the amount by which the forward or futures price exceed the spot price.
- Price Transparency – Describes quotes to which every market participant has equal access
- Quote – An indicative market price, normally used for information purposes only.
- Rate – The price of one currency in terms of another, typically used for dealing purposes.
- Risk – Exposure to uncertain change, the variability of returns significantly the likelihood of less thanexpected returns.
- Risk Capital– The amount of money that an individual can afford to invest, which, if lost would not affect their lifestyle.
- Risk Management – To hedge one’s risk they will employ financial analysis and trading techniques
- Settlement – The process by which a trade is entered into the books and records of the counterparts to a transaction. The settlement of currency trades may or may not involve the actual physical exchange of one currency for another.
- Short Position – An investment position that benefits from a decline in market price. When one sells a currency their position is short.
- Spot/Next – A currency deposit transaction or the simultaneous purchase and sale of currency, or vice versa by means of swap for spot value day against the next working day.
- Spot Price – The current market price. Settlement of spot transactions usually occurs within two business days.
- Spot (Rate) – In FX Markets, Spot refers to the cash price without interest factored in.
- Spot Trade – When you trade foreign exchange you are always quoted a spot price 2 business days in advance. This is under normal conditions where there are no bank holidays in the traded currencies countries or is not over a weekend.
- Spread – The difference between the bid (buy) and offer (ask, sell) prices; in other words the spread is the commission that the brokerage house makes on each trade. This can vary widely between currencies and between brokerage firms. For example, USD/JPY may bid at 131.40 and ask at 131.45, this five-pip spread defines the trader’s cost, which can be recovered with a favourable currency move in the market.
- Stop Loss Order – Order type whereby an open position is automatically liquidated at a specific price. Often used to minimize exposure to losses if the market moves against an investor’s position. As an example, if an investor is long USD at 156.27, they might wish to put in a stop loss order for 155.49, which would limit losses should the dollar depreciate, possibly below 155.49.
- Support Levels – A term used in technical analysis indicating a specific price level at which a currency will have the inability to cross below. Recurring failure for the price to move below that point produces a pattern that can usually be shaped by a straight line. It is the opposite of Resistance levels.
- Swap – A currency swap is the simultaneous sale and purchase of the same amount of a given currency at a forward exchange rate.
- Take-Profit – A take-profit order (T/P) is an order used by currency traders specifying the exact rate or number of pips from the current price point where to close out their current position for a profit. The rate deemed to be the level where the trader wants to take a profit is sometimes referred to as the “takeprofit point”.
- Technical Analysis – An effort to forecast prices by analyzing market action through chart study, volume, trends, moving averages, patterns, formations and many other technical indicators.
- Tick – Minimum price move.
- Ticker – Shows current and/or recent history of a currency either in the format of a graph or table.
- Trading – Buying or selling of goods and services among countries called commerce. Forex Trading is the trading of Foreign Currencies.
- Transaction Cost – the cost of buying or selling a financial instrument.
- Trend -simply the direction of the market, usually broken down to three categories….major, intermediate and short-term trends. Three directions are also associated.
- Turnover – The total money value of all executed transactions in a given time period; volume.
- Two-Way Price – When both a bid and offer rate is quoted for a FX transaction.
- Uptick – a new price quote at a price higher than the preceding quote.
- Variation Margin – Funds a broker must request from the client to have the required margin deposited. The term usually refers to additional funds that must be deposited as a result of unfavorable price movements.
- Volatility (Vol) – A measure of price fluctuations. The standard deviation of a price series is commonly used to measure price volatility.
- Volume – represents the total amount of trading activity in a particular stock, commodity or index for that day. It is the total number of contracts traded during the day.
- Weak Dollar/ Strong Dollar – dollar is said to be weak (relative to a previous time period) against another currency when more dollars are required to buy one unit of another currency. The dollar is strong or has gained in strength when fewer dollars are required to buy one unit of another currency. For example, if $1 buys 10 FF in 1989 but today $1 buys only 6 FF then the dollar has weakened against the franc.
- YIELD – Return on capital investment