Start trading Forex: Tutorial Part 4

In the previous three tutorial I have tried to give the idea of forex, how forex market works, what is buy/sell in forex, time table of forex market sessions etc. If you have missed it you can find it in the links below-

Start trading Forex: Tutorial Part 1

Start trading Forex: Tutorial Part 2

Start trading Forex: Tutorial Part 3

And today I will write about the core basics of forex without knowing them you can't trade. While trading you will find these words. So you must know what it means before you start trading.

Introduction

ISO Currency Codes

USD = US Dollar
EUR = Euro
JPY = Japanese Yen
GBP = British Pound
CHF = Swiss Franc
CAD = Canadian Dollar
AUD = Australian Dollar
NZD = New Zealand Dollar

Currency Pair Terminology

EUR/USD = "Euro"
USD/JPY = "Dollar Yen"
GBP/USD = "Cable" or "Sterling"
USD/CHF = "Swissy"
USD/CAD = "Dollar Canada" (CAD referred to as the "Loonie")
AUD/USD = "Aussie Dollar"
NZD/USD = "Kiwi"

Dealing Desk

A dealing desk provides pricing, liquidity and execution of trades. 

Forex ECN Broker

ECN is an acronym for Electronic Communications Network. A Forex ECN broker does not have a dealing desk but instead provides a marketplace where multiple market makers, banks and traders can enter in competing bids and offers into the platform and have their trades filled by multiple liquidity providers in an anonymous trading environment. The trades are done in the name of your ECN broker, thereby providing you with complete anonymity. A trader might have their buy order filled by liquidity provider "A", and close the same order against liquidity provider "B", or have their trade matched internally by the bid or offer of another trader. The best bid and offer is displayed to the trader along with the market depth which is the combined volume available at each price. A greater number of marketplace participants providing pricing to the ECN broker leads to tighter spreads. ECN's typically charge a small fee for matching trades between their clients and liquidity providers.  

Sell Quote / Bid Price

The sell quote is displayed on the left and is the price at which you can sell the base currency. It is also referred to as the market maker's bid price. For example, if the EUR/USD quotes 1.3200/03, you can sell 1 Euro at the bid price of US$1.3200.

Buy Quote / Offer Price
The buy quote is displayed on the right and is the price at which you can buy the base currency. It is also referred to as the market maker's ask or offer price. For example, if the EUR/USD quotes 1.3200/03, you can buy 1 Euro at the offer price of US$1.3203.

Spread
The difference between the sell quote and the buy quote or the bid and offer price. For example, if EUR/USD quotes read 1.3200/03, the spread is the difference between 1.3200 and 1.3203, or 3 pips. In order to break even on a trade, a position must move in the direction of the trade by an amount equal to the spread.

 
Pip
The smallest price increment a currency can make. Also known as points. For example, 1 pip = 0.0001 for EUR/USD, or 0.01 for USD/JPY.

Pip Value
The value of a pip. Pip value can be either fixed or variable depending on the currency pair. e.g. The pip value for EUR/USD is always $10 for standard lots, $1 for mini-lots and $0.10 for micro lots.

Lot
The standard unit size of a transaction. Typically, one standard lot is equal to 100,000 units of the base currency, 10,000 units if it's a mini, or 1,000 units if it's a micro. Some dealers offer the ability to trade in any unit size, down to as little as 1 unit.

Margin
The deposit required to open or maintain a position. Margin can be either "free" or "used". Used margin is that amount which is being used to maintain an open position, whereas free margin is the amount available to open new positions. With a $1,000 margin balance in your account and a 1% margin requirement to open a position, you can buy or sell a position worth up to a notional $100,000. This allows a trader to leverage his account by up to 100 times or a leverage ratio of 100:1. If a trader's account falls below the minimum amount required to maintain an open position, he will receive a "margin call" requiring him to either add more money into his or her account or to close the open position. Most brokers will automatically close a trade when the margin balance falls below the amount required to keep it open. The amount required to maintain an open position is dependent on the broker and could be 50% of the original margin required to open the trade.

Leverage
Leverage is the ability to gear your account into a position greater than your total account margin. For instance, if a trader has $1,000 of margin in his account and he opens a $100,000 position, he leverages his account by 100 times, or 100:1. If he opens a $200,000 position with $1,000 of margin in his account, his leverage is 200 times, or 200:1. Increasing your leverage magnifies both gains and losses.
To calculate the leverage used, divide the total value of your open positions by the total margin balance in your account. For example, if you have $10,000 of margin in your account and you open one standard lot of USD/JPY (100,000 units of the base currency) for $100,000, your leverage ratio is 10:1 ($100,000 / $10,000). If you open one standard lot of EUR/USD for $150,000 (100,000 x EURUSD 1.5000) your leverage ratio is 15:1 ($150,000 / $10,000).

Manual Execution
An order which is executed by dealer intervention.

Automatic Execution
The order is executed automatically without dealer intervention or involvement.

Slippage
The difference between the order price and the executed price, measured in pips. Slippage often occurs in fast moving and volatile markets, or where there is manual execution of trades.

Drawdown
The decline in account balance from peak to valley, measured until a new high is reached, usually reported in percentage terms.

Support
Support is a technical price level where buyers outweigh sellers, causing prices to bounce off a temporary price floor.

Resistance
Resistance is a technical price level where sellers outweigh buyers, causing prices to bounce off a temporary price ceiling.

Common Order Types

Market Order

An order to buy or sell at the current market price.

Limit Order

An order to buy or sell at a pre-specified price level.

Stop-Loss Order

An order to restrict losses at a pre-specified price level.

Limit Entry Order

An order to buy below the market or sell above the market at a pre-specified level, believing that the price will reverse direction from that point.

Stop-Entry Order

An order to buy above the market or sell below the market at a pre-specified level, believing that the price will continue in the same direction. 

Common Trade Types

Long Position
A position in which the trader attempts to profit from an increase in price. i.e. Buy low, sell high.

Short Position
A position in which the trader attempts to profit from a decrease in price. i.e. Sell high, buy low.

Common Trading Styles

Technical Analysis
A style of trading that involves analysing price charts for technical patterns of behaviour.

Fundamental Analysis
A style of trading that involves analysing the macroeconomic factors of an economy underpinning the value of a currency and placing trades that support the trader's long or short-term outlook.

News Trading
A style of trading whereby a trader attempts to profit from fundamental news announcements on a country's economy that may affect the value of a currency, usually seeking short term profit immediately after the announcement is released.

Scalping
A style of trading that involves frequent trading seeking small gains over a very short period of time. Trades can last from seconds to minutes.

Day Trading
A style of trading that involves multiple trades on an intra-day basis. Trades can last from minutes to hours. 

Swing Trading
A style of trading that involves seeking to profit from short to medium term swings in trend. Trades can last from hours to days.

Automated Trading
A style of trading that involves neither human decision making nor involvement, but uses a pre-programmed strategy based on technical or fundamental analysis to automatically execute trades via an automated software programme.

These are very important if you work in forex. You will face these terms in every move you make. Knowing beforehand will be handy.

That's it for today. Next lesson we will discuss about a Broker through which you can trade and will show you the way you can open a forex account.