Trading Basics

Trading Basics

Read up on anything and everything you need to know about trading Indices such as the Dow Jones, Commodities such Oil and Gold, and popular Forex pairs.


FX & CFD Trading Terminology

Forex and CFD investing is just like any endeavor, where preparation is a valuable instrument. Understanding and familiarizing yourself with terminology is valuable asset for any trader.

QUOTE

An indicative market price, when used in Forex, refers to the prevailing exchange rate of the quoted currency at that moment. A quote will always be for a currency pair; for example EUR/USD, AUD/JPY or USD/JPY. The first currency in the pair is the quoted currency, while the second currency is referred to as the counterpart.

A currency pair is usually quoted to a 1/10,000 degree of precision (i.e. until the 4th digit right of the decimal point); except for Japanese yen pairs, where quotes are usually made to 1/100 degree of precision (i.e. to the second digit right of the decimal point).

A quote will always be provided in a form of two figures. The first figure is always the Bid or selling price, while the second is the Ask or buying price.

BID/ASK

The Bid or the selling price is the exchange rate at which a currency is offered for sale. The Ask or buying price is the exchange rate at which a currency can be bought.

LOT

A lot is the standard unit size of a transaction. It represents the minimum quantity which can be traded in any given instrument.

For Forex Trading, LDC standard lot size is 1,000 units of the quoted currency.

For CFD Trading, the standard lot size varies from 1 to 500 units of the quoted CFD.

PIP

This is the smallest value in a currency quote and can be different for different currencies. For most currency pairs a pip is the 1/10,000 (0.0001) fraction of the quoted currency. However, in Japanese yen pairs, a pip refers to a 1/100 (0.01) fraction of the quoted currency.

Profits on a trade can be expressed in pips, for example: Suppose you bought the EUR/USD at an exchange rate of 1.5016 and sold it at an exchange rate of 1.5037. 37-16=21. You made a 21 pip profit.

PIP VALUE

The pip value can be either variable or fixed, depending on the currency pair it refers to and the base currency (i.e. measuring currency) of your account. The pip value is also a function of the amount traded.

The simplest way to calculate the pip value is to divide 1 pip by the exchange rate and multiply it by the lot size. This gives you the pip value in terms of the quoted currency. If the base currency of your account is other than the quoted currency, then simply multiply this by the applicable exchange rate.

For example: What is the pip value of a trade in GBP/JPY with a price of 128.92? The pip value of 1 standard lot (5,000) of GBP/JPY which is traded at 128.92 is:

0.01/128.92 = 0.00007756 GBP

0.00007756 x 5,000=0.387 GBP

The base currency of your account is USD. If the exchange rate for GBP/USD is 2.0612, then the pip value for 1 standard lot in terms of the account's base currency is: 0.387x 2.0612 = $0.80.

SPREAD

This is the difference between the bid price and the ask price. For example: If the quote for the EUR/USD pair is 1.5034/1.5037 (in other words the bid price is 1.5034 and the ask price is 1.5037), then the spread for the EUR/USD in this case is 3 pips. Low spreads ensure that traders can get in and out of their trades at very low slippage.

MARGIN

The amount of funds required to open or maintain a position. It is usually expressed as a percentage of the open position. You may have a margin requirement of 0.5%, which would mean that in order to hold a position of 100,000 EUR/USD, an equity level of 500 euros or more must be maintained.

LEVERAGE

This is the use of borrowed capital to increase potential return. Trading on leveraged capital means that you can trade amounts significantly higher than the balance of your funds, which only serves as the margin. High leverage can significantly increase the potential return, but it can also significantly increase potential losses. The leverage is specified as a ratio, such as 200:1. This means that the trader can trade amounts 200 times higher than the sum in his or her margin account. If the trader has $1,000 in his account, it means that he can now open trades worth $200,000.

INTEREST

In a sense, interest is the price of money. It is the amount paid on loans and received on deposits.

LONG

A trader going long expects the price to go up when buying a currency pair or a CFD.

SHORT

A trader going short expects the price to go down when selling a currency pair or a CFD.

VALUE DATE

The date on which counterparts to a financial transaction agree to settle their respective obligations, i.e., exchanging payments.

ROLLOVER

Process where the settlement of a deal is rolled forward to another value date and a charge is levied based on the difference in rates of interest of the two currencies. Every day, at 21:00GMT, open positions are rolled over to the next day and the positions gain or lose interest based on the interest differential between the bought and sold currencies.

If you buy overnight a currency pair where the base currency has a higher interest rate than the terms currency, then you’ll receive interest and vice versa.


Forex and CFD Trading Orders

There are various types of orders which a trader can use to trade Forex and CFDs. Below we outline the different order types: Market Order, Stop-Loss / Limit Orders, Entry Orders, Trailing Stop-Loss Orders and One-Cancels-the-Other Orders.

MARKET ORDER

A market order is an order to buy or sell at the current ask or bid price quoted on the market. The buy order may be to initiate a new position or liquidate a previous sell position. The sell order may be to initiate a new position or liquidate a previous buy position.

STOP-LOSS / LIMIT ORDERS
  • Stop-Loss and Limit orders are protective orders that close an open position or future position under certain conditions, namely price.
  • Stop-Loss Orders are used to limit trader's losses if the market moves against their position. The trader sets the maximum amount (in terms of pips) that he is willing to lose on a certain trade. When that specified price is reached, the trade is executed.
  • Conversely, Limit Orders are used to lock in the trader's profit if the market moves favorably. The trader sets in advance the price at which he wants to close his position.
ENTRY ORDERS

These types of orders open a new position only if the market reaches a price specified by the trader.

Entry orders are divided into two varieties: Entry Limit Orders and Entry Stop Orders.

  • Entry Limit Orders – Entry limit orders are orders that are placed by traders to enter the market at a more favorable price than the current price. When Buying a currency pair or a CFD, a Entry Limit order will be placed below the current market price. When Selling, a limit entry order will be placed above the current market price. When placing Entry Limit Orders, the trader expects that the market price will bounce back after reaching the level at which the entry limit order was placed.
  • Entry Stop Orders – Entry stop orders are orders that are being placed by traders to enter the market at a less favorable price than the current price. A BUY Entry Stop order will be placed above the current market price. When A SELL Entry Stop order will be placed below the current market price. When placing Entry Stop Orders, the trader expects that once the market's momentum breaks through the specified price, the trend's movement is confirmed and will continue in that direction.
TRAILING STOP-LOSS ORDERS

A trailing stop-loss order is a stop-loss order that is set by the trader at a fixed number of pips from his entry rate. The stop loss order is automatically moved as the market price moves, but only in the direction of the investor's trade.

For example:

  • If you're Long on the USD/CAD pair at 1.0552 and you set the trailing stop at 30 pips, the stop will initially become active at 1.0522 (=1.0552-0.030).
  • If the USD/CAD moves higher to 1.0565, the stop-loss order adjusts higher, pip by pip, with the market price and will then be active at 1.0535 (=1.0565-0.030).
  • If the USD/CAD ever goes down by 30 pips from 1.0565 to 1.0535, your stop will be triggered and your position closed. If the market goes up from 1.0565, your trailing stop will continue to move up in order to lock in additional profits.
ONE-CANCELS-THE-OTHER ORDERS (OCO)

OCO orders are combined orders with both a stop price and a limit price. When one of the orders is executed, the other is automatically cancelled. OCO orders can be applied to open positions, or they can be used to open a new position.

Stop and limit orders entered on an existing position are also types of OCO orders. When either the stop or the limit is executed, the other is automatically canceled.