Forex Trading Basic Terms
Q- What do we mean by “bid/ask” and “spread”?
A- The price that the seller is offering for the particular currency at a particular time is called bid. It is always a little bit lower than the market price. In the currency pair, the Forex bid price appears to the left of the currency quote. Let’s say, If the GBP/USD pair is 1.3057/59, then the bid price is 1.3057. Meaning you can sell one GBP for 1.3057 USD. Ask is the price acceptable to the buyer. It is always a little bit higher than the market price. It appears to the right of the Forex quote. For example, in the aforesaid GBP/USD pair of 1.3057/59, the ASK price us 1.3059. This means you can buy one GBP for 1.3059 USD. Difference between the two is called as a spread. So spread is the type of commission we pay to our broker for every trade.
Let’s understand spread with an example, EUR/USD Bid/Ask currency rates are 1.1550/1.1551. You will buy the pair at the higher Ask price of 1.1551 and sell it at the lower Bid price of 1.1550. So, here the spread is of 1 pip (1.1551-1.1550)
Q- What is a lot in the Forex market?
A- A lot is a number of currency units, In Forex, a standard lot size is of 100,000 units of base currency, in other words, one standard lot of GBP/USD is a position worth 100,000 British pounds. Likewise Mini and micro lots are also available to traders; a mini-lot is worth 10,000 units and a micro-lot is worth 1000 units of the currency being bought or sold.
Commonly used lots sizes in Forex trading are as follow:
1 lot = 1,00,00 units of base currency (Standard lot)
0.1 lot = 10,000 units of base currency (Mini lot)
0.01lot = 1,000 units of base currency (Micro lot)
Q- What is Rollover?
A-Rollover is also called rollover swap. A swap rate is a rollover interest rate, which broker credits to or debits from clients’ accounts when a position is held open overnight. Swap charges are released weekly by the liquidity providers we work with. Each currency pair has its own swap charge.
The calculation will be as follows:
Swap = (One Point / Exchange Rate) * Trade Size (Lot Size) * Swap Value in Points
One Point: 0.00001
Currency Pair: GBP/USD
Account Base Currency: GBP
Exchange Rate: 1.3016 (GBP/USD)
Volume in Lots: 5 (One Standard Lot = 100,000 Units)
Short Swap Rate: 0.15
Swap Value = (0.00001 / 1.3016) * (500,000 * 0.15)
Swap Value is £0.58
*In case the result is negative, your account will be debited whereas if it is positive your account will be credited.
Q- What is a required margin in forex trading?
A- Required margin is a ‘security’ deposit – required by the broker to open position. This is not a charged to your account, nor it is a commission but serves to ensure that you have adequate balance in your account with regard to the size of your position. The margin is affected by the trade size and leverage. So, the broker will lock money into the margin account as soon as you open a trade. You can’t utilize it until your broker returns it back to you either when you close your current orders or when you receive a margin call.
We can calculate the required margin with the help of the below-mentioned formula:
Required Margin = Trade Size / Leverage * currency exchange rate
Let’s say trade size is 100,000, Leverage is 1:500 and EUR/USD exchange rate is 1.1543.
Let’s put formula now:
Required Margin = Trade Size(100,000) / Leverage(1:500) * currency exchange rate(1.1543)
Required Margin= 230.86 USD
Q- What is “margin call”?
A- Margin call is a warning from your broker that you need to close your open trades or fund your account to meet the minimum margin requirement. If you fail to do so, your open trades will close the account as soon as your equity drops to 40% of the margin( percentage depends on the broker you trade through). Due to such policy, no trader has ever lost more funds than they had in their account. Margin calls can be avoided by carefully monitoring your account balance on a regular basis, and by using stop-loss orders on every position to minimize the risk.
Q- Why is it good to place profit limit and stop loss orders?
A- The stop-loss works as a backup to close the position and to protect you from further losses when the market moves against your will. When the market touches stop loss value, the position is closed automatically. The same thing happens when you place a profit limit.
Q- What is the stop out?
A- The margin call is deemed as a first warning, on the other hand, the stop out is the automated action taken to protect your account going into a negative balance.
Q- What is the main difference between margin call and stop out?
A- Let’s understand the difference with an example. Suppose that you have a live trading account with a Forex broker that has a 40% margin call level and a 15% stop out level. Your balance is evaluated at $10,000, and you open one trade with a $1,000 margin. If the loss on this trade reaches $9,600, your account will reflect $400 equity ( $10,000 – $ 9,600 = $400). This is already 40% of your used margin, so the broker will send a margin call alert. So, when your loss on trade reaches $9,850 and your account equity reflects $10,000 – $9,850 = $150 (i.e., 15% of the used margin), Here, Forex broker will close you’re losing trades to protect your account from negative balance.
Q- What is the difference between a limit order and a stop order?
A- Limit and stop orders are both pending orders that direct a broker to close or open a position when an asset’s price touches a certain level. Traders often get confused with a limit order and a stop order. Sell limit orders direct that a position is opened when the market price touches a level that is above than the current market price. Buy limit orders direct that a position be opened when the market price touches a level below than the current price,
Conversely, buy stop orders are placed above the current market price and sell stops are placed below the current market price.
Q- How is trading done?
A- Forex trading is usually done through brokers. Brokers are basically companies offering traders with access to the interbank market where transactions take place. In simple words, a Forex broker provides you a software program (MT4), which enables trader can watch live currency quotes and also enables traders to place orders to buy/sell currencies with just a few clicks. When a trader closes his position, the Forex broker closes the same position on the interbank currency market and credits your MT4 account with the loss or gain. It takes only a few clicks to open a live account with the online broker of your will and start Forex trading. A trader pays spread or commission to his broker who acts as a medium between trader and liquidity providers. Now let’s talk about what exactly trader does, Trader buys/sells one currency against another, it means trader opens a long/short position on a currency pair. For example, the current price of the GBP/USD pair is 1.6000. If you expect the GBP to rise against US dollar, you open a long position on GBP/USD. After a few minutes the price of GBP/USD rises, you close the position and earn the profit. Let’s take the same example again, the current price of the GBP/USD pair is 1.6000. If you expect the GBP to go down against US dollar, you open short position on GBP/USD. After a few minutes the price of GBP/USD declines, you close the position and earn the profit. Profit is based on how much the price of this currency pair has fluctuated during this duration and the size of your position. If your assumption was wrong and GBP/USD against your will, you will suffer loss. Traders who expect the prices to decline are called ‘bears’, while those who expect a rise are known as ‘bears’.
Q- How do I calculate profit and losses?
A- When a trader closes his position, he can calculate profit and losses using below mentioned formula:
Price(exchange rate) at the time of selling the base currency – price at the time of buying the base currency X transaction size = profit or loss
Let’s suppose you buy GBP (GBP/USD) at 1.5178 and sell GBP at 1.5188. If the transaction size is 100,000 GBP, you will have a $100 profit. ($1.5188 – $1.5178) X 100,000 = $.001 X 100,000 = $100. likewise, if you sell GBP (GBP/USD) at 1.5170 and buy GBP at 1.5180, you will suffer a loss of $100. ($1.5170 – $1.5180) X 100,000 = – $.001 X 100,000 = – $100. A trader can also calculate his unrealized profits and losses on open positions. Just replace the current bid or ask rate for the action you will take while closing a position. Let’s say, if you purchased GBP at 1.5178 and the current BiD rate is 1.5173, you have an unrealized loss of $50. ($1.5173 – $1.5178) X 100,000 = – $.0005 X 100,000 = – $50. In the same way, if you sold GBP at 1.5170 and the current ask rate is 1.5165, you have an unrealized profit of $50. ($1.5170 – $1.5165) X 100,000 = $.0005 X 100,000 = $50.In case, the quote currency is not in US dollars, you will have to convert the profit or loss to US dollars at the dealer’s rate. Moreover, if the broker charges some fee or commission, you must subtract those fees and commission from your profits and add them back to your losses to calculate your actual profits and losses.
Q- Who are dealing desk and non-dealing desk brokers?
A- Market Makers or Dealing Desk brokers, create own market for their traders and usually take the other side of their clients’ trades. Dealing desk brokers earn money basically through spreads and commission if any. Interbank Market rates access is not possible for the clients of Market Makers, however, they can get benefit from the fixed spreads that dealing desk brokers normally provide. When a trader opens a buy order with a dealing desk broker, they will try to search a matching sell order from their other clients or move on your order on to their liquidity providers in order to minimize risk as much as possible. However, market makers may take the reverse side of your trade when they are not able to find any matching orders to fill your order.
On the other side, a no dealing desk broker does not interfere with the trades. Meaning is simple, that these brokers do not take the other side of their clients’ trade as they simply link two parties together. No dealing desk brokers can be STP broker or ECN broker, STP brokers just pass the trades to their liquidity providers who have any access to the interbank market. So their liquidity providers are always ready to buy or sell any currency pair at any point in time. This means that they simply link two parties together with the help of liquidity providers. Many brokers act as an ECN provider but the truth is that they are STP brokers. It is very difficult for individual retail traders to get through to the interbank market so STP brokers act as bridges to the retail forex traders. No dealing desk brokers find the best bid, ask for the spread on this market for their traders. Most of STP brokers offer variable spread to their traders. As far as ECN brokers are concerned, they have direct access to the interbank market.
Q- How much money can I earn in Forex trading?
A- This is the most frequently asked question of every new trader. The Unfortunate thing is that there’s no simple answer, the reason being is that it depends how much risk you can take.
Forex Trading is a function of risk and reward: The more you risk, the more you can earn. Let’s take an easy example: Let’s assume you start with a $500 account and you would like to take risk of $100. You could now place a trade to go long at the opening, set a stop loss of $100 and a profit goal of $100. Let’s say you analyzed the market performance in the past few months and found that your probability of achieving your profit goal is 70%.
Unluckily the trade you just opened starts moving in negative, and you lose the whole $100. As this was the amount you were ready to lose, you finally close your account, withdraw the remaining $400 back into your online wallet.
Let’s take another scenario, you would like to take risk of $10 per trade and you fixed your profit goal to $10, too. You have decided now to open at least 10 trades. If all 10 trades are going negative, you will lose the $100 which you are going to invest. Let’s no go in mathematics, but if we talk about statistics, it says that the probability of losing 10 trades is less than 1%. Hence, it’s more likely that you will have a few positive trades out of 10 trades. Again, If your analysis shows the same results as it did in the previous scenario (70% winning), you should make $40: 3 losing trades * $10 = -$30 + 7 winning trades * $10 = $70. Hope it makes sense.
Let’s move forward and compare these two options:
- The chances of losing your funds in scenario 1 is 30%. However, if you won, you would have made $100.
- As far as scenario 2 is concerned, the chances of losing your funds after 10 trades are less than 1%, however, you have a very good chance of earning $40.
For that reason, you have to determine first how much you are ready to lose because the amount you can earn is a reward of that risk which you are taking. I hope it makes sense.
Remember that there’s a difference between the amount you’re willing to risk and the amount you need for trading. One more thing is that your broker always need “margin” as a security, and you have to deposit according to the margin requirement + your risk.
Q- What is slippage and why are the causes of slippage?
A- Slippage happens when an order is filled at a price that is not similar to the requested price.
Slippage is a common thing to experience as a Forex trader because trade size and price on a buy order must be similar to sell orders of equal size and price.
Slippage can work either negatively or positively. The important causes of slippage are execution speed, Forex market volatility expected and unexpected economic events and due to natural or man-made disasters, etc. When this occurs, the liquidity provider will complete the trade at the next available price.
Avoiding slippage is not possible, however, it can be minimized. One way for traders to reduce slippage is to make sure that their broker works with a number of liquidity providers. The second way for traders to avoid slippage is to avoid opening trades during the duration of high volatility. As we discussed earlier that volatile trading periods usually increase the chances of slippage because price moves on the fast track and at wider intervals.
Examples of Forex Slippage:
Suppose the price of the EUR/USD was 1.15010. After analysis, you think that the pair is on an upward trend and long a one standard lot trade at the current price of EUR/USD 1.15050, expecting order to be filled at the same price of 1.15050.
The market follows an upward trend but moves above your execution price and up to 1.15060 in very short time– within a second. This is because the price (1.15050) which you expected is not available in the market, therefore, you are offered the next available price.
Let’s assume, you would experience positive slippage:
1.15050 – 015045 = 0.00005, or you can say +5 pips.
Let’s take another scenario, in this scenario the trade was executed at 1.15055. You would then experience negative slippage:
0.15050 – 0.15055 = -0.0005, or you can say -5 pips.
So, please keeps it in mind that you can experience slippage with all types of requested orders which includes Stop Loss, Take Profit, Buy/Sell Stops and Buy/Sell Limit Orders.
Q- What is a demo account and is it good for practice?
A- If you are new to trading and want to learn forex or you just want to test a new strategy then you go first try demo account. A demo account enables you to experience risk-free trading and try-out your strategies on a live market.
There is no need to deposit your own funds on Forex right away. In this market, most of the brokers offer demo accounts where you can do practice. The demo account will allow you to test out the live forex market using virtual money. However, everything has its advantages and drawbacks as well. Similarly, a demo account contains both. As we discussed earlier, a demo account will let you practice your skills using virtual money. No matter whether you make a mistake, you will not lose anything. It sounds appealing but there are hidden drawbacks. Firstly, demo accounts are filled with bigger funds by brokers which enables beginners to select higher lot size and it also enables them to take higher risk. Moreover, with large money on a demo account, the trader never understand real losses as it can be easily regained by a big capital than by a small one. Secondly, another big drawback of the using demo account is the lack of real emotions. There is a saying that when you have nothing to lose, you can’t experience a loss. Loss of a real account lets trader’s to learn risk management and to control their emotions. Therefore, it doesn’t make any sense to test your emotions and skills on a demo account.
Q- At what time forex market open?
A- Forex market is the only market in the world which opens 24 hours a day and 5 days a week i.e from Sunday evening until Friday night. Each day of forex markets begins with the opening of the Australasia area, followed by European session and then North American session. As soon as one region’s market closes another opens or has already opened. Traders can trade anytime as they like during the working week, therefore, it provides a great chance for traders to trade at any time of the day or night.
Forex trading hours:
New York opens from 8:00 am to 5:00 pm EST (EDT)
Tokyo opens from 7:00 pm to 4:00 am EST (EDT)
Sydney opens from 5:00 pm to 2:00 am EST (EDT)
London opens from 3:00 am to 12:00 noon EST (EDT)
These three sessions overlap during a few hours:
New York and London: from 8:00 am to 12:00 noon EST (EDT)
Sydney and Tokyo: from 7:00 pm to 2:00 am EST (EDT)
London and Tokyo: from 3:00 am to 4:00 am EST (EDT)
In aforesaid overlapping trading hours, traders find huge fluctuation, therefore, traders get more chances to earn in the foreign exchange market.