Before you decide to jump into foreign exchange market as a broker or as an investor, you must acquire a basic knowledge of how this market operates and the terms used in it. The foreign exchange market never shuts down and operates 24 hours a day on all working days. It is the largest liquid financial market. It’s not like a typical ‘market’ or stock exchange. There is no central trading location. All the transactions are conducted over the telephone or electronic foreign exchange trading networks. The ‘interbank market’ is the primary market for currencies. First of all, remember foreign exchange has been abbreviated to ‘forex’ and ‘FX’ by the people who are active participants in foreign exchange trading. Here is a list of the basic terms used in forex trading.
- Exchange Rate: The exchange rate expresses the value of one currency in terms of another. For example, AUD/JPY = 88.6348352. This means, 1 Australian dollar is equal to 88.6348352 Japanese yen.
- Currency Pair: The two currencies shown in an exchange rate are called a ‘currency pair’. The first currency is known as the ‘base’ currency, and the second one in the pair is called ‘counter’ or ‘terms’ or ‘quote’ currency.
- Currency Codes: There are eight major currencies which are traded in the forex market. There is a three character code that denotes the country. The major currencies are;
USD = US Dollar
EUR = Euro
JPY = Japanese Yen
GBP = British Pound
CHF = Swiss Franc
CAD = Canadian Dollar
AUD = Australian Dollar
NZD = New Zealand Dollar
- Lot: The standard unit size of a transaction. A 100,000 units of the base currency are called a standard lot. If its 10,000 units, traders refer to it as ‘mini’ and 1,000 units are called ‘micro’.
- Pip: This is the smallest unit in price quote for currency. Beginners will note that forex traders quote currencies with 4 decimals. For example if a price is quoted as 1.2345 the last digit ‘5’ is known as ‘pip’. If it goes up by 3 pips it would be 1.2348.
- Bid and Ask Price: The bid price is the price at which the forex market will buy a particular currency from you. The ask price is the price they are ready to sell a currency to you. The market makes money when the ask price is higher than the bid price. The difference in the two prices is known as the bid/ask spread.
- Sell Quote / Bid Price: The sell quote is the currency on the left of the pair known as the base currency. For example, if AUD/USD = 1.0532/03, this means you can sell 1 Australian dollar at the bid price of US$ 1.0532.
- Buy Quote / Offer Price: The buy price is displayed on the right of the currency pair. This is the price at which you can purchase the base currency. It is also known as the market maker’s ask or offer price. For example AUD/USD = 1.0532/03 means that you can buy 1 Australian dollar for US$ 1.0532.
Once you are familiar with these basic terms of forex trading you can take the plunge and learn more advanced terminologies and how this unseen market operates.
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