Forex Trading Basics

This article will introduce you to the basic terms used in by Forex traders. It is absolutely necessary to know them well, otherwise you could face the significant problems during currency trading.

Exchange Rate

For every currency there has been the abbreviation code assigned by an ISO (International Standards Organization). During the trades, codes are used to indicate which particular currencies match the trading pair. Example: EUR/USD shows two currencies, Euro and Dollar.

The first one of them is called the base one, the second is the quote (or counter) currency. Exchange rate is simply the ratio of the base currency to the quote one.

When buying, the exchange rate shows how much trader has to pay in the quote currency to get one unit of the base currency. When selling, the exchange rate specifies how much can trader get in the quote currency for selling one unit of the base currency. In EUR/USD Euro is a base and American Dollar is a quote.

Bid/Ask Price

Exchange rate is usually given as a bid and ask price, where the bid price is always lower than the ask price. The bid price indicates what will be obtained in the quote currency if selling one unit of the base currency. The ask price shows what the trader has to pay in the quote currency to get one unit of the base currency. The following price is for example of the bid/ask notation EUR/USD: 1.3850 / 1.3851

In this example, 1.3850 represents the bid price (what trader gets in Dollars when he sells Euro). 1.3851 marks the ask price (how much trader has to pay in Euro if he's buying Dollars).

Spread

Spread is the difference between the bid and ask. In the example above, the spread is 0.0001 - 1 pip. Some currency pair quotes are carried out to the 3rd decimal place, unlike the pair that's in example higher. USD/JPY for example may be quoted at 119.505/119.510, so, 5 pips are representing the difference in 0.005 in this case.

It is obvious that the spread can have the significant influence on the amount of profit the trader obtains. Especially if he is a short time trader and opens a lot of orders.

Buying

Buying (or going long) the currency pair means buying the base currency and selling the equal amount of the quote currency in order to pay for the first one. It's not really necessary to own the quote currency prior to go selling, because it is sold short. Trader goes long when he expect the base currency price to increase against the quote one.

Selling

Selling (or going short) the currency pair means that the trader sells the base currency and buys the quote currency. Trader goes short if he thinks that the exchange rate of the base currency is about to decline against the quote currency.

Open trade

Open trade (or position) describes the situation when trader bought or sold the currency but didn't close the deal, waiting for the maximal profit.

Forex trading hours

Forex is a global market. Traders from different parts of the world are more active during some specific time of the day, which is connected to the significant time difference. Along with that, banks and financial institutions from the different world regions actively participate in currency trading mainly during the local office hours. That is why the trading day is divided into the trading sessions.

There are 4 main trading sessions:
Sydney- 10:00 pm - 7:00 am GMT
Tokyo- 12:00 am - 9:00 am GMT
London - 8:00 am - 5:00 pm GMT
New York- 1:00 pm - 10:00 pm GMT

The biggest amounts of currency have been trade during the New York trading hours. That is why the US trading session is considered to be the most active.

Direct, Indirect and Cross Rates

Direct Rates are the rates of the currency pairs where USD is the base, and the quote currency expresses a number of units paid per 1 Dollar. For example USD/JPY

Indirect rates are the rates of the currency pairs where the US Dollar is a quote, GBP/USD as example.

Cross Rate stays to the currency pairs where Dollar is not included. Although, trading two currencies with no Dollar usually mean trading one against the Dollar and then the Dollar against second one. For example EUR/CHF or GBP/EUR.

Leverage

Leverage in forex has very important meaning. Traders, who cannot afford investing the considerable amount to the Forex account, can use leverage to receive the considerable income. Leverage if forex can be up to 500:1, which means which means that for every dollar you invest, you can buy the amount of foreign currency equal to 500 dollars.

Even though the leverage looks like a gift of heaven, it can play against you as well, since it works on the losing trades as well.

You're now familiar with the basic forex terms that will allow you to understand the market, although there is still a lot to learn in order to become the successful currency trader.

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