As in any
new skill that you learn, you need to learn the lingo... especially if you wish
to win your love's heart. You, the newbie, must know certain terms like the
back of your hand before making your first trade. Some of these terms you've
already learned, but it never hurts to do a little review.
Major and Minor Currencies
The eight
most frequently traded currencies (USD, EUR, JPY, GBP, CHF, CAD, NZD, and AUD)
are called the major currencies or the "majors." These are the most
liquid and the most sexy. All other currencies are referred to as minor
currencies.
Base Currency
The base
currency is the first currency in any currency pair. The currency quote shows
how much the base currency is worth as measured against the second currency.
For example, if the USD/CHF rate equals 1.6350, then one USD is worth CHF
1.6350.
In the
forex market, the U.S. dollar is normally considered the "base"
currency for quotes, meaning that quotes are expressed as a unit of 1 USD per
the other currency quoted in the pair. The primary exceptions to this rule are
the British pound, the euro, and the Australian and New Zealand dollar.
Quote Currency
The quote
currency is the second currency in any currency pair. This is frequently called
the pip currency and any unrealized profit or loss is expressed in this
currency.
Pip
A pip is
the smallest unit of price for any currency. Nearly all currency pairs consist
of five significant digits and most pairs have the decimal point immediately
after the first digit, that is, EUR/USD equals 1.2538. In this instance, a
single pip equals the smallest change in the fourth decimal place - that is,
0.0001. Therefore, if the quote currency in any pair is USD, then one pip
always equal 1/100 of a cent.
Notable
exceptions are pairs that include the Japanese yen where a pip equals 0.01.
Pipette
One-tenth
of a pip. Some brokers quote fractional pips, or pipettes, for added precision
in quoting rates. For example, if EUR/USD moved from 1.32156 to 1.32158, it
moved 2 pipettes.
Bid Price
The bid
is the price at which the market is prepared to buy a specific currency pair in
the forex market. At this price, the trader can sell the base currency. It is
shown on the left side of the quotation.
For
example, in the quote GBP/USD 1.8812/15, the bid price is 1.8812. This means
you sell one British pound for 1.8812 U.S. dollars.
Ask/Offer Price
The
ask/offer is the price at which the market is prepared to sell a specific
currency pair in the forex market. At this price, you can buy the base
currency. It is shown on the right side of the quotation.
For
example, in the quote EUR/USD 1.2812/15, the ask price is 1.2815. This means
you can buy one euro for 1.2815 U.S. dollars. The ask price is also called the
offer price.
Bid/Ask Spread
The spread is the
difference between the bid and ask price. The "big figure quote" is
the dealer expression referring to the first few digits of an exchange rate.
These digits are often omitted in dealer quotes. For example, the USD/JPY rate
might be 118.30/118.34, but would be quoted verbally without the first three
digits as "30/34." In this example, USD/JPY has a 4-pip spread.
Quote Convention
Exchange rates in the forex market are expressed using the
following format:
Base currency / Quote currency = Bid / Ask
Base currency / Quote currency = Bid / Ask
Transaction Cost
The
critical characteristic of the bid/ask spread is that it is also the
transaction cost for a round-turn trade. Round-turn means a buy (or sell) trade
and an offsetting sell (or buy) trade of the same size in the same currency
pair. For example, in the case of the EUR/USD rate of 1.2812/15, the
transaction cost is three pips.
The
formula for calculating the transaction cost is:
Transaction
cost (spread) = Ask Price - Bid Price
Cross Currency
A cross currency is any pair in which neither currency is the U.S. dollar. These
pairs exhibit erratic price behavior since the trader has, in effect, initiated
two USD trades. For example, initiating a long (buy) EUR/GBP is equivalent to
buying a EUR/USD currency pair and selling GBP/USD. Cross currency pairs
frequently carry a higher transaction cost.
Margin
When you
open a new margin account with a forex broker, you must deposit a minimum
amount with that broker. This minimum varies from broker to broker and can be
as low as $100 to as high as $100,000.
Each time
you execute a new trade, a certain percentage of the account balance in the
margin account will be set aside as the initial margin requirement for the new
trade based upon the underlying currency pair, its current price, and the
number of units (or lots) traded. The lot size always refers to the base
currency.
For
example, let's say you open a mini account which provides a 200:1 leverage or
0.5% margin. Mini accounts trade mini lots. Let's say one mini lot equals
$10,000. If you were to open one mini-lot, instead of having to provide the
full $10,000, you would only need $50 ($10,000 x 0.5% = $50).
Leverage
Leverage
is the ratio of the amount capital used in a transaction to the required
security deposit (margin). It is the ability to control large dollar amounts of
a security with a relatively small amount of capital. Leveraging varies
dramatically with different brokers, ranging from 2:1 to 500:1.
Now that
you've impressed your dates with your forex lingo, how about showing her the
different types of trade orders?
