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Common Terms in Foreign Exchange Trading

August 25, 2014

Abiola Akinwale



UNDERSTANDING the key terms in forex is critical to investors who are exploring forex for the first time and, while it may seem overwhelming initially, there are only a few fundamental concepts you need to know before giving trading a try.

In previous columns I have explained what a currency pair is and the different currency pairs that are available to trade. I have also outlined how to read a forex quote, including the base currency, the quote currency and the quoted rate. The next stage is to understand what a "pip" is.

What is a pip?

"PIP" stands for "Percentage in Point" and it is a standard unit of measurement used to express the change in value between two currencies in forex trading. A pip is usually the last decimal place of a currency pair quotation, and in the case of US dollar (USD) pairs, 1 pip is equal to $0.0001.

Traders use pips to calculate a point for profits or losses. For example, if the EUR/USD rate is at 1.3250 and it moves to 1.3251, this means the pair has strengthened by 0.0001.

In other words, the pair has changed in value by 1 pip.There are some exceptions to this rule, such as pairs involving the Japanese yen (JPY) which are quoted to only two decimal places. For example, if USD/JPY is at 93.60 and it moves to 93.61, this means that the pair has changed in value by one pip.

What is a fractional pip?

While most currencies are quoted to four decimal places, or two in the case of the Japanese yen, some forex brokers also offer currencies quoted to five decimal places (or three decimal places in the case of yen pairs). This last decimal point is referred to either as a "pipette" or a "fractional pip". A fractional pip quotation for EUR/USD would be quoted this way: 1.32501. The advantage of trading with fractional pips is that it allows you to benefit from very small price increments in the market.

What is the spread?

All currency pair quotes are provided with two prices; these are referred to as the "bid price" and the "ask price". The bid price is the rate at which the broker is willing to buy an asset and the ask price is the rate at which the broker is willing to sell the asset. Meanwhile the spread is the difference between the bid and ask price - it is effectively the cost of doing business with your broker. If your broker offers you tighter spreads this means you are being charged less for each trade and you will benefit from better value for money.

How big is a "lot"?

In forex, a "lot" is the size of the trade you are making and it is defined by the number of units in each individual trade. The value of a "standard lot" is 100,000 units of the base currency. There are also smaller sized trades, known as "mini lots" and "micro lots" which are 10,000 and 100 units respectively.

Lots means number of units. There is standard lot (100,000); mini lot (10,000); and micro lot (1000).

The smallest size of a trade with most forex brokers is a micro lot, which is 1000 units of the base currency. Micro lots are popular with traders new to forex as they provide flexibility in trading and offer lower risks. Assuming you made a deposit in US dollars, 1 micro lot would be equal to $1000 worth of the base currency you are looking to trade. If the pair you are going to trade is a USD pair, 1 pip would be equal to 10 cents.

As a mini lot consists of 10,000 units of the currency you funded your account with, each pip in a trade would be worth around $1 if you made your deposit in US dollars. While this seems like a small amount to be trading, the forex market has the potential to move very fast in one day and it is possible for movements of 100 pips or more to be seen in a day and, occasionally, even in just one hour, which is why it is so important to ensure you have a proper risk strategy in place.

Standard lots are made up of 100,000 units of the base currency, which is the equivalent of $100,000 if you are trading in dollars. As the average is around $10 per pip, this size of trade is mainly undertaken by experienced forex traders and institutional traders.

Choosing the correct size of a trade is very important and it should form part of a comprehensive risk management strategy. Traders should never risk more than they can afford to lose.

For more information and to meet other forex traders, ForexTime Nigeria organizes regular training events at their offices in Lagos, Abuja and Port Harcourt as well as traders' conferences across the country.

Visit www.forextime.com/forex-partners/global-networks/fxtm-nigeria for more details.

Disclaimer: The content in this article comprises personal opinions and ideas and should not be construed as containing personal and/or other investment advice and/or an offer of and/or solicitation for any transactions in financial instruments and/or a guarantee and/or prediction of future performance. ForexTime Ltd, its affiliates, agents, directors, officers or employees do not guarantee the accuracy, validity, timeliness or completeness of any information or data made available and assume no liability as to any loss arising from any investment based on the same.

Risk Warning: There is a high level of risk involved with trading leveraged products such as forex and CFDs. You should not risk more than you can afford to lose, it is possible that you may lose more than your initial investment. You should not trade unless you fully understand the true extent of your exposure to the risk of loss. When trading, you must always take into consideration your level of experience. If the risks involved seem unclear to you, please seek independent financial advice.

- Mr. Akinwale works with ForexTime Nigeria.


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Source: AllAfrica


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