Currency Pairs
Every FOREX trade involves the simultaneous buying of one currency and the selling of another currency. These two currencies are always referred to as the currency pair in a trade.
Major and Minor Currencies
The seven most frequently traded currencies (USD, EUR, JPY, GBP, CHF, CAD, and AUD) are called the major currencies. All other currencies are referred to as minor currencies. The most frequently traded minors are the New Zealand Dollar (NZD), the South African Rand (ZAR), and the Singapore Dollar (SGD). After that, the frequency is difficult to ascertain because of perpetually changing trade agreements in the international arena.Cross Currency
A cross currency is any pair in which neither currency is the U.S. Dollar. These pairs may exhibit erratic price behavior since the trader has, in effect, initiated two USD trades. For example, initiating a long (buy) EUR/GBP trade is equivalent to buying a EUR/USD currency pair and selling a GBP/USD. Cross currency pairs frequently carry a higher transaction cost. The three most frequently traded cross rates are EUR/JPY, GBP/EUR, and GBP/JPYExotic Currency
An exotic is a currency pair in which one currency is the USD and the other is a currency from a smaller country such as the Polish Zloty. There are approximately 25 exotics that can be traded by the retail FOREX participant. Liquidity—the ability to buy and sell without substantial pip spread increases; a willing buyer or seller is always available at or near the last price—is not good. Whereas a EUR/USD pair may be traded at two pips at almost any time, the EURTRY may balloon to 30 pips or more during the Asian session.Base Currency
The base currency is the first currency in any currency pair. It shows how much the base currency is worth as measured against the second currency. For example, if the USD/CHF rate equals 1.6215, then one USD is worth CHF 1.6215. In the FOREX markets, the U.S. 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 exceptions are the British Pound, the Euro, and the Australian Dollar. If you go long the EUR/USD, you are buying the EUR.Quote Currency
The quote currency is the second currency in any currency pair. This is frequently called the pip currency and any unrealized profit or loss is expressed in this currency. If you go short the EUR/USD, you are buying the USD.Pips
A pip is the smallest unit of price for any foreign currency. Nearly all currency pairs consist of five significant digits and most pairs have the decimal point immediately after the first digit, that is, EUR/USD equals 1.2812. In this instance, a single pip equals the smallest change in the fourth decimal place, that is, 0.0001. Therefore, if the quote currency in any pair is USD, then one pip always equals 1 ⁄100 of a cent. One notable exception is the USD/JPY pair where a pip equals $0.01 (one U.S. Dollar equals approximately 107.19 Japanese Yen). Pips are sometimes called points.Ticks
Just as a pip is the smallest price movement (the y-axis), a tick is the smallest interval of time (the x-axis) that occurs between two trades. When trading the most active currency pairs (such as EUR/USD or USD/JPY) during peak trading periods, multiple ticks may (and will) occur within the span of one second. When trading a low-activity minor cross pair (such as the Mexican Peso and the Singapore Dollar), a tick may only occur once every two or three hours. Ticks, therefore, do not occur at uniform intervals of time. Fortunately, most historical data vendors will group sequences of streaming data and calculate the open, high, low, and close over regular time intervals (1-minute, 5- minute, 30-minute, 1-hour, daily, and so forth). Pips are a function of price; ticks are a function of time. Any location on a chart is effectively a Cartesian coordinate of Price, read vertically from bottom to top and Time, read horizontally from left to right.Margin
When an investor opens a new margin account with a FOREX broker, he or she must deposit a minimum amount of monies with that broker. This minimum varies from broker to broker and can be as low as $100 to as high as $100,000. Each time the trader executes a new trade, a certain percentage of the account balance in the margin account will be earmarked as the initial margin requirement for the new trade based on the underlying currency pair, its current price, and the number of units traded (called a lot). The lot size always refers to the base currency. An even lot is usually a quantity of 100,000 units, but most brokers permit investors to trade in odd lots (fractions of 100,000 units). A mini-lot is 10,000 units and a micro-lot is generally considered to be 1,000 units. A standard lot is 100,000 and a bank lot is 250,000 units. For U.S. retail FOREX traders the minimum margin has been set by the NFA to 1 percent (100:1 leverage) for major currency pairs and 4 percent (25:1 leverage) for exotics.Leverage
Leverage is the ratio of the amount used in a transaction to the required security deposit (margin). It is the ability to control large dollar amounts of a security with a comparatively small amount of capital. Leveraging varies dramatically with different brokers, ranging from 10:1 to 400:1. Leverage is frequently referred to as gearing. Typical ranges for trading are 50:1 to 100:1. The formula for calculating leverage is Leverage 100/Margin Percent The most typical leverage used by traders in retail FOREX is 50:1 to 100:1. Some brokers offer up to 400:1. A new trader should start with very low leverage, perhaps 20:1 and certainly no higher than 50:1. To some extent, FOREX traders set their own leverage insofar as they determine the lot size to trade. But your broker-dealer will set a maximum.Bid Price
The bid is the price at which the market is prepared to buy a specific currency pair in the FOREX market. At this price, the trader can sell the base currency. It is shown on the left side of the quotation. For example, in the quote USD/CHF 1.4527/32, the bid price is 1.4527, meaning that you can sell one U.S. Dollar for 1.4527 Swiss Francs.Ask Price
The ask is the price at which the market is prepared to sell a specific currency pair in the FOREX market. At this price, the trader can buy the base currency. It is shown on the right side of the quotation. For example, in the quote USD/CHF 1.4527/32, the asking price is 1.4532, meaning that you can buy one U.S. Dollar for 1.4532 Swiss Francs. The asking price is also called the offer price.Bid-Ask Spread
The spread is the difference between the bid and asks price. The “big figure quote” is the dealer expression referring to the first few digits of an exchange rate. These digits are often omitted in dealer quotes. For example, a USD/JPY rate might be 117.30/117.35, but would be quoted verbally without the first three digits as “30/35.” You buy the ask and sell the bid. TIP: Be sure you know to what accuracy your broker provides currency quotes. Many now quote in fractional (1 ⁄10) pips. This may be referred to as “Four Digit Pricing” and “Five Digit Pricing.”
Quote Convention
Exchange rates in the FOREX market are expressed using the following format: Base Currency/Quote Currency Bid/Ask Examples can be found in Table. Normally only the final two digits of the bid price are shown. If the asking price is more than 100 pips above the bid price, then three digits will be displayed to the right of the slash mark (that is, EUR/CZK 32.5420/780). This only occurs when the quote currency is a weak monetary unit.Brokers
Brokers are of two types, although some gray areas, terms such as liquidity provider and No Dealing Desk (NDD), have appeared recently. A market maker is a counterparty to each transaction. In effect, they are acting as their own mini-exchange. At one end market makers are tapped into the Interbank market—often indirectly—and at the other end are the retail customers. What goes on in-between could be a book unto itself. An Electronic Communications Network (ECN) broker is simply a matchmaker. They also have liquidity providers at one end—usually banks, sometimes other ECNs—and clients at the other. An ECN simply matches orders.
Transaction Cost
The critical characteristic of the bid-ask spread is that it is also the transaction cost for a round-turn trade. Round-turn means both a buy (or sell) trade and an offsetting sell (or buy) trade of the same size in the same currency pair. In the case of the EUR/USD rate, as seen earlier in Table, the transaction cost is three pips. The formula for calculating the transaction cost isTransaction Cost =Ask Price- Bid Price
In FOREX you buy the ask and sell the bid. You offset a trade by closing the trade, not executing the opposite action—buy if you are short, sell if you are long. Market-maker brokers add their profit into the spread. Electronic Communication Network brokers (ECNs) charge a small commission per lot