Forex Trading Tools: Common Forex Trading Terms

The foreign exchange market, or Forex market, is an around-the-clock cash market where the currencies of nations are bought and sold. Forex trading is always done in currency pairs. For example, you buy Euros, paying with U.S. Dollars, or you sell Canadian Dollars for Japanese Yen. The value of your Forex investment increases or decreases because of changes in the currency exchange rate or Forex rate. These changes can occur at any time, and often result from economic and political events. The purpose of this article is to discuss commonly used Forex trading terms.

Bid and Ask Price: Like the stock market, the Forex market has a bid and ask price. The bid is the price you can sell at. The ask is the price you can buy at.

Bid/Ask Spread: The bid/ask spread or simply spread is the distance between the bid and ask prices. This spread is usually expressed in pips. For example, if the the bid price is 1.2362 and the ask price is 1.2365, the spread between the bid and ask prices is 3 pips wide (1.2365 - 1.2362 = 3 pips).

Lots: 1 Lot is equal to 100,000 units of the base. Likewise, 2 Lots are equal to 200,000 units of the base, 3 Lots are equal to 300,000 units of the base, and so on.

Margin: Margin is referred to as the collateral needed to facilitate a Forex deal. Usually, this is a very small portion of the entire deal, say 1% or 1:100. Please note that margin is a double-edged sword. Without the proper use of risk management tools (for example, the stop-loss option), you can experience substantial losses as well as gains.

Long Position/Short Position: A long position is a market position that appreciates in value if the market price increases. Conversely, a short position is a market position that appreciates in value if the market price decreases. (In every open Forex position, you are long in one currency and short in the other.)

Stop-Loss Order: A stop-loss order is a market order to close a Forex position if or when losses reach a pre-set threshold. According to Bruce Kovner: Whenever I enter a position, I have a predetermined stop. That is the only way I can sleep. I know where I am getting out before I get in. The position size on a trade is determined by the stop, and the stop is determined on a technical basis. Ed Seykota adds: The elements of good trading are: (1) cutting losses, (2) cutting losses, and (3) cutting losses. If you can follow these three rules, you may have a chance.

Take-Profit Order: A take-profit order is a market order to close a Forex position if or when profits reach a pre-set threshold.

Fundamental Analysis: A fundamental analysis uses economic and political factors, such as unemployment rates, interest rates, or inflation, as a means of predicting currency movements. Fundamental analysis is concerned with the reasons or causes for currency movements. Many Forex traders who rely on fundamental analysis plan their trading strategies around a number of key U.S. Government economic indicators. Some of these indicators are the Gross Domestic Product (GDP), Foreign Exchange Rates, the Composite Index of Leading Indicators, the Consumer Price Index (CPI), Retail Sales, Housing Starts, the Employment Cost Index, and Consumer Confidence.

Technical Analysis: A technical analysis uses historical data as a means of predicting currency movements. The technical analyst believes that history repeats itself over and over again. Technical analysis is not concerned with the reasons for currency movements (for example, interest rates or inflation). Instead, it believes that historical currency movements are a clear indication of future ones.

Trading System: According to Howard Abell, The trading system gives the trader the ability to control his or her emotional states rather than allowing them to control him. A system is a disciplined method for organizing dynamic, ever-changing market phenomena.

Trading Forex on margin carries a high level of risk, and may not be suitable for all investors. The high degree of leverage can work against you as well as for you. Before deciding to invest in foreign exchange you should carefully consider your investment objectives, level of experience, and risk appetite.