Forex

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Forex

Foreign Exchange (forex or FX) is the process of trading one currency for another, creating a global marketplace for exchanging national currencies. For instance, you can exchange the U.S. dollar for the Euro.

Forex trading involves simultaneously buying one currency while selling another, forming what is known as a currency pair. Currencies are always traded in pairs, with each currency represented by a unique three-letter code.

The first two letters in the code signify the country, while the third letter identifies the currency. For example, JPY represents the Japanese Yen. A currency rate for the Euro against the U.S. Dollar might be quoted as: EUR/USD = 1.23700.

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When an investor speculates that the price will go up, they will buy the currency to sell it later at a higher price.

Related terms: Buy (Long, Bullish, Hawkish)

When an investor speculates that the price will go down, they will sell the currency to buy it later at a lower price.

Related terms: Sell (Short, Bearish, Dovish)

When you sell (go short) the EUR/USD:

Selling the Euro

Buying the US dollar

When you buy (go long) the EUR/USD:

Buying the Euro

Selling the US dollar

Point, Pip, and Tick are price measurements used by traders to describe price changes in financial markets:

Point: The largest price change of the three measurements, representing the smallest possible price change on the left side of the decimal.

Pip: Short for "point in percentage," a pip represents the smallest price change on the right side of the decimal (often the fourth decimal place for most currency pairs).

Tick: The smallest possible price change, also typically to the right of the decimal point.

Examples:

1. If the price of EUR/USD increased from 1.19600 to 1.19610, by how many pips did the price increase?

Calculation: 1.19610 - 1.19600 = 0.00010

Answer: 1 Pip

2. If the price of EUR/USD increased from 1.18700 to 1.18800, by how many pips did the price increase?

Calculation: 1.18800 - 1.18700 = 0.00100

Answer: 10 Pips

3. If the price of EUR/USD decreased from 1.18701 to 1.18700, by how many ticks did the price decrease?

Calculation: 1.18701 - 1.18700 = 0.00001

Answer: 1 Tick

A contract size is a standardized amount that specifies the exact quantities being bought or sold, based on the terms of the contract.

The size of the contract varies depending on the commodity or instrument.

A contract is also referred to as a lot or standard lot.

1 standard lot = 100,000 base currency

If you are buying or selling 1 contract of EUR/USD, it means that you are buying or selling 100,000 of the base currency — 100,000 Euros.

Examples of Contract Sizes:

0.5 Contract = 50,000 Base Currency

0.1 Contract = 10,000 Base Currency (Mini Lot)

0.01 Contract = 1,000 Base Currency (Micro Lot)

If the price of EUR/USD increases from 1.18000 to 1.18001, this represents a change of 1 Tick.

1 Tick Change Values by Lot Size:

1 Lot = $1

0.1 Lot = $0.1

0.01 Lot = $0.01

Bid Price is the price at which the investor is willing to sell the currency.

Ask Price, also known as the offer, is the price at which the investor is willing to buy the currency.

Spread is the difference between the bid and ask prices.

For example: 0.091926 – 0.91899 = 0.00027

The spread in the above case is 2.7 pips or 27 ticks.

1 standard lot = 100,000 base currency

To calculate a long transaction's profit or loss, use the following formula:

(Closing price – Opening price) * Number of Contracts * Contract Size

Example:

A trader bought 2 EUR/USD contracts at 1.20500 and sold them at 1.22000.

Solution: (1.22000 – 1.20500) * 2 * 100,000 = USD 3,000

To calculate a short transaction's profit or loss, use the following formula:

(Opening price - Closing price) * Number of Contracts * Contract Size

Example:

A trader sold 3 AUD/USD contracts at 0.77500 and bought them at 0.76000.

Solution: (0.77500 - 0.76000) * 3 * 100,000 = USD 4,500

Unrealized P/L: Unrealized P/L refers to the profit or loss in your current open positions. It represents the profit or loss that would be “realized” if all open positions were closed immediately. Unrealized P/L is also known as “Floating P/L” because it constantly changes as long as positions are open.

Balance: Balance is the amount available without considering unrealized/floating profit and loss.

Equity: Equity is the available net balance. It is equal to balance ± profit or loss.

What is Margin? When trading forex, you are only required to put up a small amount of capital to open and maintain a new position. This capital is known as the margin.

What is Leverage? Leverage is the use of various financial instruments or borrowed capital to increase the potential return of an investment. However, it may also increase your risk exposure.

When margin is expressed as a specific amount of your account’s currency, this amount is known as the Required Margin.

Each position you open will have its own Required Margin amount that will need to be “locked up.” Required Margin is also known as Deposit Margin, Entry Margin, or Initial Margin.

For example, let’s look at a typical EUR/USD (euro against U.S. dollar) trade. To buy or sell 100,000 EUR/USD without leverage would require the trader to put up $100,000 in account funds, the full value of the position. But with a Margin Requirement of 2%, only $2,000 (the “Required Margin”) of the trader’s funds would be required to open and maintain that $100,000 EUR/USD position.

If you add up all of the Required Margin of all open positions, the total amount is what’s called the Used Margin.

Free Margin is the amount available to use to enter new trades. Free Margin = Equity – Used Margin.

Margin Level allows you to know how much of your funds are available for new trades. It is calculated as:

Margin Level = (Equity / Used Margin) * 100%

The higher the Margin Level, the more Free Margin you have available to trade. A lower Margin Level means less Free Margin is available, which could lead to a Margin Call or Stop Out.

When the Margin Level reaches 100%, it means your equity is equal to your used margin, which is called a Margin Call.

When the Margin Level reaches 20%, this is called the Stop Out Level. If this level is reached, your broker will automatically start closing out your trades, starting with the most unprofitable one, until your Margin Level is back above the Stop Out Level.

Market Order (Market Execution): An order to buy or sell an instrument at the current market price, directly filled at the price available.

Take Profit: Automatically closes a position when the asset's price reaches a predetermined level, allowing a trader to lock in profits at that point.

Stop Loss: Automatically closes a position when the asset's price reaches a specified level, helping traders limit potential losses by exiting the trade at a predetermined point.

Pending Orders (Limit Orders): Limit orders allow a trader to buy or sell a currency pair at a specific price above or below the current market price.

  • Buy Limit Order: A buy limit is a pending order that instructs a broker to buy an instrument at a price lower than the current market price when that price level is reached. It is often used to enter a trade at a more favorable price point.
  • Sell Limit Order: A sell limit is a pending order that instructs a broker to sell an instrument at a price higher than the current market price when that price level is reached. It is often used to initiate a trade at a more favorable price point.
  • Buy Stop Order: A buy stop is a pending order that instructs a broker to buy an instrument at a price higher than the current market price when that price level is reached. It is often used to enter a trade as the price rises, potentially continuing an upward trend.
  • Sell Stop Order: A sell stop is a pending order that instructs a broker to sell an instrument at a price lower than the current market price when that price level is reached. It is often used to initiate a trade as the price declines, potentially continuing a downward trend.