Learn to Trade Forex

02 - Basic Terminology

Typography

Before trading currencies, an investor has to understand the basic terminology of the forex market, including how to interpret forex quotes and calculations.

Straight Through Processing (STP) Broker

Pepperstone is an STP broker to provide clients with direct access to other participants in the currency market by consolidating price quotations from several banks. Pepperstone clients have instant access (Straight Through Processing) to some of the best prices with extremely tight spreads.

Pips and Pipettes

Pepperstone quotes currency pairs by "5, 3 and 2" decimal places – these are known as fractional pips or pipettes.

  • On a 5 decimal place currency pair a pip is 0.00010
  • On a 3 decimal place currency pair a pip is 0.010
  • On a 2 decimal place currency pair a pip is 0.10

For example: If GBP/USD moves from 1.51542 to 1.51552, that .00010 USD move higher is one pip.

Spread

The spread is the difference between the BID and the ASK price in the market quotes. The ASK price is applicable to a BUY order and the BID price is applicable to a SELL order.

Pepperstone operates using variable spreads, which are spreads that don't have the same constant value. A variable spread will condense and widen as market conditions and liquidity change.

Leverage

Leverage is the ability to control a large amount of money in the forex markets.

For example: Pepperstone offers a maximum leverage of 500:1 which means for every $1 that you have in your trading account; you can trade $500 on the forex market. The same principal applies to all base currencies and leverage amounts.

Leverage gives the trader the ability to make meaningful profits on the normally miniscule daily currency movements, and, at the same time, risk only minimal capital on a given position.

Leverage can exponentially increase your profits as well as your losses so it is crucial that traders take care when using leverage. The larger your position size, the larger your pip value will be and therefore, the greater the impact on your profit/loss (P/L).

Margin

Margin is the term given to the amount of money required in your account in order to open a trade.

Margin is calculated based on the current market quote of the base currency of the trader's account vs base currency of the trader's account, the volume requested, and the leverage level of the trader's account.

Free or available margin is indicated in the MT4 trading terminal.

Margin may be calculated as follows: (Current Market Quote * Volume) / Leverage = $Margin Required

For example:

  • A trader wants to open 0.1 (10,000 base currency) lots of EUR/USD at the current market quote of 1.4177 and with a leverage level of 1:200.
  • The base currency of the account is USD.
  • (1.4177 * 10,000) / 200 = $70.89 required to open a 0.1 lot position

Margin Call

A margin call is a warning message that occurs when a trader's account is running out of sufficient funds to sustain their current open positions on the market.

If the market moves against a trader's position/s, additional funds will be requested through a "margin call".

If there are insufficient available funds, the trader's open positions will be closed out

If a trader's Equity (Balance - Open Profit/Loss) falls below a specific margin level which is the amount required to support open positions, then the trader's positions will automatically be closed.

This is calculated as follows for the MetaTrader 4 platform: Equity / Margin = < 20%

This is calculated as follows for the cTrader platform: Equity / Margin = < 50%

Hedging

Hedging refers to the opening of a new position in the opposite direction of an existing position on the same instrument.

For example: To hedge a 0.1 lot Buy position on AUD/USD, you would open a 0.1 lot Sell position on AUD/USD

No additional margin is required to hedge a position. It is important to note that one cannot open a new position on an account with insufficient usable margin.

Rollovers/Swaps

Forex trading may also generate interest income as well as capital gains. Since forex is traded in pairs, every trade involves not only two different currencies, but their two different interest rates.

If the interest rate of the currency a trader bought is higher than the interest rate of the currency a trader sold, then the trader will earn interest or "rollover" (positive roll).

If the interest rate on the currency the trader bought is lower than the interest rate on the currency you sold, then the trader will pay rollover (negative roll).

Rollovers/swaps can add a significant extra cost or profit to a trade. The rollover amount increases/decreases as the position size increases/decreases.

Rollovers take place at 5pm EST (New York Time)

Commissions

These are fees that Pepperstone charges on the Razor account only. The commission amount equates to:

Lot Size Commission Amount Notes
0.01

0.1

1
AU$0.07

AU$0.70

AU$7
Round turn means that commission is only paid when positions are closed

** The commission amount increases/decreases as the position size increases/decreases

Expert Advisor (EA)

EA's are algorithmic programs that have been developed to open trades on behalf of investors on the MetaTrader 4 platform. Expert Advisors are based on signals generated by various technical indicators and may be acquired online.

Virtual Private Server (VPS)

A VPS is used to keep the Meta-Trader 4 platform running even if the trader exits the program. This minimizes the chance of system downtime due to technology and connectivity failures.

MAM/PAMM Accounts

Multi Account Manager account types on the Meta-Trader 4 platform are designed for Money Managers who trade on behalf of other investors and manage multiple accounts from a single interface. Money Managers can also manage multiple accounts by utilising Expert Advisors (EAs).

Safe Haven Currencies

This is a term used to describe trading an alternative currency or instrument that is less volatile as a result of market turmoil and uncertainty. Safe haven currencies or instruments are considered low risk because their issuing governments are stable and their economies tend to be strong, however, this does not necessarily mean that they are 'safe'.

One-Click-Trading

Allows you to open a new position with just one click

Pepperstone
Pepperstone is authorised and regulated by the Australian Securities and Investment Commission (ASIC) and the Financial Conduct Authority (FCA). We take pride in our strong culture of regulation and compliance. The security of our client funds is of paramount importance. Pepperstone maintains segregated client accounts with National Australia Bank (Australia) and Barclays (UK).
More from the author