9 Basic Forex Terms You Should Know Before Trading

Trading in the foreign exchange (forex) market can be a daunting experience for a beginner. But, with a basic understanding of forex terms and concepts, you can quickly become comfortable trading fiat currencies. Today's article will discuss nine of the most important terms used in forex trading, such as leverage, margin, pips, and spreads.

Moreover, we will also discuss some key concepts, like the importance of having a trading strategy and understanding the different types of order executions. With this knowledge, you can start trading currencies with confidence. So let's get started and learn the basics of forex trading.

1. Currency Pairs

In simple terms, currency pairs are the two currencies that make up a currency exchange rate. A currency pair is typically listed as a number of base currency units per one quote currency unit. They are divided into three main categories: major, cross, and exotic pairs.

Major Pairs are the pairs of currency that are most commonly traded, and include:

• EUR/USD
• USD/JPY
• GBP/USD
• AUD/USD

Cross Pairs are currency pairs that do not include the US dollar and most commonly include:

• EUR/GBP
• NZD/JPY
• CHF/JPY

Exotic Pairs are currency pairs that involve less commonly traded currencies, such as:

• EUR/TRY
• USD/MXN
• CAD/JPY

So, if you are looking to trade, let's say dollars and euros, you would be looking for the EUR/USD currency pair.

» Learn more about CFDs on forex currency pairs available for trading

2. Exchange Rate

An exchange rate is a price for exchanging one currency for another. Exchange rates are determined by a variety of factors, such as supply and demand, economic conditions, and political stability, and can be either floating or fixed.

• Floating exchange rate: The value of the currency is determined by the market and can change from moment to moment. For example, the EUR/USD has a current exchange rate of 0.97. This means that one euro is worth 0.97 US dollars.
• Fixed exchange rate: The value of the currency is set by a central bank and remains constant. A popular example is the Danish Krone, which is fixed to the euro at 7.4 DKK per 1 EUR.

3. Leverage

Leverage is the use of borrowed capital to increase one's buying power in the forex market. You can use leverage to trade larger amounts of currency than what you have in your trading account.

For example, if you have a trading account with a brokerage that offers 50:1 leverage, it means that you can trade up to the value of $50 for every $1 in your account. This way, you can make larger trades than you could otherwise with just your own capital.

If you’re still a forex beginner who’s not completely familiar with all the forex trading terms, it wouldn't be the best idea to start using leverage just yet. For beginners, it is best to start with a demo account that offers leverage and practice trading without risking your own capital.

4. Bid / Ask Price / Spread

Understanding the terms bid, ask price, and spread is essential for any investor looking to trade in the forex market. They refer to the prices of currencies when buying and selling, as well as the difference between those two prices.

• Bid price: The bid price is the highest amount of money a buyer is willing to pay for a currency pair. For example, if the EUR/USD bid price is 0.96, this means that a buyer is willing to pay 0.96 US dollars for one euro.
• Ask price: The ask price is the lowest amount of money a seller is willing to accept for a currency pair. For example, if the ask price of EUR/USD is 0.97, this means that a seller is willing to accept no more than 0.97 US dollars for one euro.
• Spread: The spread is the difference between the bid and ask price. It is typically expressed as a percentage of the mid-market rate and can vary depending on the market conditions. In the examples we used the bid price for EUR/USD was 0.96 and the ask price was 0.97, which results in a spread of 0.01.

5. Long / Short Position

In forex trading, your position (long or short) refers to your expectations of the market. If you think the market will go up, then you take a long position. Conversely, if you think the market will go down, then you take a short position.

• Long position: A long position is when an investor opens a buy trade of a CFD currency pair expecting its value to increase. The investor will then open a sell trade at a later point in time at a higher price, thus making a potential profit.
• Short position: A short position is when an investor opens a sell trade of a CFD currency pair expecting its value to decrease. The investor will then open a buy trade at a later point in time at a lower price, thus making a potential profit.

6. Margin

In forex trading, a margin is the amount of money a trader must put up in order to open and hold a position, expressed as a percentage of the total position size. 

Typically, this money acts as collateral for the brokerage to cover any losses if the trade goes against the trader. Some of the key terms you need to understand related to margin are:

• Used margin is the amount of money in your trading account that is used to open and maintain a position.
• Free margin is the amount of money in your trading account that is available to open new positions.
• Margin call is when a trader or investor has an account that has fallen below the brokerage’s minimum margin requirement, then the brokerage can place a margin call on the account, in which case the investor would have to either deposit additional funds into their account, or close some of the trades they are holding.

7. Pip

Pip is the smallest unit of measurement when trading currencies, and generally refers to 1/100th of 1% or 0.0001. For example, if the EUR/USD exchange rate moves from 0.96123 to 0.96124 this would be considered one pip movement.

• Fractional pips or pipettes are even smaller units of measurement and are expressed as 1/10th of a pip. For example, if the EUR/USD exchange rate falls from 0.961221 to 0.961220 this would be considered a 0.1 pip, or one-tenth of a pip movement.
• Pip value is an important term to factor in, and this is the amount by which a currency pair moves when the exchange rate changes. It is calculated by multiplying one pip (0.0001) by the amount of currency being traded. For example, if you traded 10,000 units of EUR/USD and the exchange rate moved by 1 pip, the value of this movement would be 10,000 x 0.0001 = 1 USD.

8. Lot size

A lot size refers to the number of currency units being traded in a forex position. Commonly, it is expressed as a standard lot, a mini lot, or a micro lot.

• Standard lot is the equivalent of 100,000 units of the base currency in a forex trade.
• Mini lot is 10,000 units of the base currency.
• Micro lot is 1,000 units of the base currency.

By specifying the amount of currency being traded, traders can better manage their risk and ensure they are trading within their risk tolerance.

In some cases, brokerages can also offer fractional lot sizes which give traders more flexibility to control the size of their trades. For example, a fractional lot size might be 0.01 of a standard lot which is equal to 1,000 units of the base currency.

9. Bear Market / Bull Market

A bear market is a market trend in which prices are falling and investors are selling off their holdings. In the forex market, this means that the value of a currency is decreasing.

For example, if the EUR/USD exchange rate continues falling for months on end (usually 3-6 months), analysts would say that we’re in a bear market.

A bull market is a market condition in which prices are rising and investors are buying up assets, leading to price increases. In the forex market, this means that the value of a currency is increasing.

In essence, both bear and bull markets can provide possibilities for traders to make profits, depending on their trading strategy.

For example, a trader could open long positions when the market is in a bullish trend and then sell when it turns bearish. Alternatively, they could short-sell when the market is in a bearish trend and then make profits on the falling prices. By trading these trends appropriately, traders can take advantage of both bear and bull markets.

Using Forex Terms in Practice

Using the forex trading terms acquired from this guide can help you understand the trading process whether you're a pro or a beginner. It can help save time so that you're not going back and forth to understand what is happening when opening a new trade.

The terms provided are meant to be a starting point to help you get started. With the expertise we have on hand, we wanted to make forex terms and trading a smooth process. Opening a trading account with Fortrade can help you on your path to making a potential profit.