Basic Terms

Trading can seem complicated first, although in reality there are only three options available when trading – go long (buy), go short (sell) or do nothing and wait for an opportunity.

However, it is important to be aware of some key terms and the concepts behind them as they relate to the Forex and CFD markets.

Leverage & Margin

Leverage, sometimes called “gearing” in the UK and Australia, provides the ability to trade a larger amount with a much smaller amount in your account. Leverage is the ratio between the amount of money you really have and the amount of money you can trade.

Leverage is expressed as a ratio and is usually expressed with an “X:1” format.

Margin, on the other hand, is used to provide the ability to trade using leverage.

In Forex trading, for example, if you wanted to trade 1 standard lot of GBP/USD without margin, you would need £100,000 in your account. But with a Margin Requirement of just 1%, you would only have to deposit $ 3,333.33 in your account, based on a standard leverage of 30:1.

In CFD trading, however, you would only need a small percentage of the total trade value to open the position and maintain the same level of exposure, as we saw in the previous lesson.

Benefits & Risks

Leverage can enable you to get the most out of your investment capital by allowing you to trade large positions and commit just a fraction of the trade value as an initial deposit. However, just as gains are increased, so are losses.

You can also take much larger positions than you would otherwise be able to with physical purchases, relative to your capital. Just remember, if the market goes against your positions, you could lose all of the funds in your account, so it is important to understand how to manage your level of risk when trading.

– Your returns as a percentage of your initial deposit can be higher
– You can spread your risk by trading different instruments
– For retail traders, the correct application of leverage is important to success

Pips & Points

In Forex, a “pip” stands for ‘percentage in points’.

A pip is the unit of measurement to express the change in value between two currencies.

If EUR/USD moves from 1.1050 to 1.1051, that .0001 USD rise in value is ONE PIP.

Most pairs go to four significant decimal places, but there are some exceptions, like Japanese Yen pairs, that only go to two decimal places.

For example, for EUR/USD, it is 0.0001, and for USD/JPY, it is 0.01.

There are Forex brokers that quote currency pairs beyond the standard four and two decimal places, and use five and three decimal places respectively, instead.

These fractional pips are called“pipettes” and in MetaTrader 4 they are called “points”.

In CFD trading, a point is the equivalent of a Forex pip. Somewhat confusingly, the first decimal of a point is often called a “pip”!

Bid & Ask Price

When trading financial markets, you are provided with two prices: the ask (buy) price and the bid (sell) price.

The bid price is always lower than the ask price and the difference between the ask and bid price is called the spread, which is a cost  to the trader for opening a position on a market.

As an example, if the market window on your trading platform quotes EURUSD at 1.13956/1.13961, then this would mean that the bid price is 1.13956 and the ask price is 1.13961.

When going long or “buy” a specific instrument, your position will be opened at the ask price and closed on the bid price.

On the other hand, when you go short or “sell”, your position will be opened on the bid price and and closed on the ask.

Spread & Commission

The spread on financial markets is the difference between the buy (ask) price of an instrument and the sell (bid) price of an instrument. When placing a trade on the market, the spread is also the main cost of the position. The tighter the spread, the lower the cost of trading. The wider the spread, the more it costs. You can also view the spread as the minimum distance the market has to move in your favour before you could start earning a profit.

Brokers need to make money. Some brokers will inflate the spread and that will constitute their cost of doing business. Other brokers will give the lowest spread possible and will cover their costs by charging a commission instead.

Stop Loss & Take Profit

A stop loss is a defined limit at which your trade will automatically close out at a loss. Stop losses are used to ensure that trades will only lose a minimum amount of money, and are an essential component in calculating position sizing.

We will cover stop losses and position sizing in greater detail in this course.

Take profit is a defined limit at which your trade will automatically close out for a profit. Take profit levels halt any further increase in profit, but guarantee a profit once that level has been reached.

Liquidity & Volatility