forex terminology

5 Essential Forex Trading Terminology

Ever read an article about Forex trading that made your head spin? 

If you had, then you probably wanted to ask the writer if there's an English version of that article because some of the terminologies he or she used are foreign to you. 

Well, fortunately, you're in the right place because this article defines all the basic Forex trading terminology that you should be familiar with so that you can move on to advanced Forex topics. 

The terms discussed here: pips, leverage, lot sizes, spread, and brokers.


1. Pips


Pip is probably the most common word you'll hear or read about in the world of Forex trading, and you may have seen "pip" pop out (that sounds funny) a few times in some of the articles in Intellinvestors. 

But, if the next step you take is to grab a dictionary, prepare to be disappointed because its definition there is different.

It's common for people in finance to shortcut everything, including words and phrases — FIFO (first in, first out), LIFO (last in, first out), and the most obvious one, in this case, foreign exchange, aka Forex.

what is a pip

Pip isn't excluded.

It's just the shortened form of percentage in point.

It starts at the fourth decimal place of a currency pair's quotation.

For example, the EUR/USD is quoted at 1.1901. If the quote moves up to 1.1909, then that's an 8-pip jump (1.1909 – 1.1901 = 0.0008 or 8 pips).

2. Lot sizes


Now, it wouldn't make sense to start counting pips at this point if you have no clue about how it affects trades.

Here's an elucidation: the direction of the pips determines your profit or loss from a trade, and that direction is either an increase or decrease in value. 

You already know that to make a profit, you need to sell something at a price that far exceeds the cost.

So, if you had bought the EUR/USD at the exchange rate of 1.1901 and sold it for 1.1909, then you profited with $0.0008 or eight pips — not much, right?

But that's when lot sizes make it interesting.

Obviously, you wouldn't waste time haggling over trifles, so trading in more substantial quantities makes it worth your while.

pip transaction

Traders don't usually trade a single currency for another — the airport might be a better place to do that.

In actuality, retail traders trade units of currencies in hundreds of thousands — sometimes even millions!

Therefore, the mere $0.0008 gain would be amplified (by trading 100,000 units of Euros) to an $80 profit.


The lot sizes in Forex:

Micro Lot = 1,000 units

Mini Lot = 10,000 units

Standard Lot = 100,000 units



3. Leverage


The next logical question you may have is this: Does that mean I have to have $119,010 (€100,000) in my trading account to gain that $80 in the sample transaction?

The answer is yes, and no.

Yes, because if you have that amount of risk capital, there's no reason for you not to do it.

And, no, because most brokers can provide you leverage.

Leverage allows you to take on a trade with a volume larger than the size of your trading account.

leverage factored

When you start trading currencies, you have the option to use the leverage provided by your broker.

Think of it as borrowed money.

Here's how it works: Going back to the EUR/USD example, you know that to get the $80 profit, you must have at least $119,010, but using leverage would permit you to put down only $1,000 to collect that gain.

It's kind of like down payment, but there are no monthly installments for you to concern yourself about.

Everything takes place in your trading account.

Here's the effect: The $1,000 taking on a €100,000 position will have a higher pip value that can go in two directions. At $10 per pip, you either end up with an $80 profit or an $80 loss to your account.

how leverage works

That’s why you’ll hear most people in the Forex industry say that leverage is a double-edged sword because you either finish the day + 8% or – 8% (from a $1000 account) with that particular transaction. 

And, mind you, an 8% move in one day in other investments is high.


4. Spread


Do you know how your broker earns its revenue? 

The answer is through the spread.

The spread is the difference between the quoted buy and sell prices for a currency pair

In your trading platform, you'll see that the price to buy a currency pair is much higher than the cost to sell it, and that's the revenue of your broker.

mt4 eur usd spread

Brokers may quote the currency pairs they offer distinctively from other brokers, and often it's one of their value propositions to acquire clients.

It's especially helpful for you to know what your broker's spreads are because it can affect the way you trade. 

A higher spread would obviously mean that it takes a bit more time for you to see profits as opposed to having narrower ones.

Lastly, leverage plays a role in spreads.

When you employ sizable leverage, your broker jumps for joy because it's not just you who can magnify earnings but your broker as well.

The only difference is that your broker is guaranteed with income while you, on the other hand, are not.

mt4 eur usd spread

The sample quote from the above image for the EUR/USD is 1.1901, which is the BUY price.

If you want to sell it, the quote will be lower, say, 1.1899, denoting a 2-pip spread.

Factoring in the 100x leverage, you have the potential to earn or lose $80 from the sample transaction.

But, your broker stands to gain a guaranteed $20 from the spread regardless if you win the trade or not.


5. Broker


This last term is here just in case you still don't know what it means.

A broker is your link to the market and is often represented by a company, not necessarily a sole individual anymore.

A good broker provides you with the necessary tools, flawless trade execution, and full-on guidance to help you in trading.

Be sure to trade with a reputable company because your broker will determine a large portion of your success.

Learn how to select the best Forex broker for you by reading our guide.

Conclusion


By remembering the basic terms discussed here, you can brace yourself for more reading materials that contain Forex jargon.

You can also appreciate now how it all ties in from the definition of a pip to the main moneymaker of your broker as all these terms are very closely related. 

Try to impress your friends by showing off some of the things you learned here. *Wink*



24 thoughts on “5 Essential Forex Trading Terminology

  1. Wow! What a simpler approach you have used in breaking down the terminologies associated with forex. Though I must say, forex is a very complicated and complex market but with seriousness and dedications to reading and practicing, it is very possible to be a success with it. Terminologies are essential to the learning and I like this post a lot. Thanks

  2. To whoever has written this I am so grateful to you. I actually bought a book on forex trading and I ended up getting confused totally on what I saw in the ebook. I thought to myself that I have wasted my money but now that you have explained all this terminologies I can confidently read the book now and understand. I am indebted to you. Thank you so much.

    1. Thanks, Henderson!  We truly appreciate your comment.   Hopefully, you can attack that book now after reading this. 😉

  3. This article was written for me as my head always spins when I read anything about trading and forex.

    I always wondered what PIP meant and now I finally know thanks to you.

    Also often wondered why in spreads the broker always earns something, even if you don’t. Seems a bit unfair to me. But it is probably safer to spread your risk and not lay all your eggs in one basket.

    I will now try and impress my clever brother with the new lingo that I have learned today.

  4. Thank you. Out of all of them I think I understood the whole thing about Pips the most. I am still very new to any kind of stock trading. I’ve always thought I would like to get into it but I never had the money so I never looked into it. Now that I am starting an online business I think I will have money to invest one day and hopefully help my money grow faster. So I appreciate your articles.
    For me, the more beginner friendly and simple, the better. But I’m sure they are also intermediate and advanced Forex traders who will come here looking for information to so I’m sure that whatever you write will be good. Take care and perhaps I’ll be back again soon.

  5. I have started in January 2019 unfortunately I have blown my account only just because I have noticed that I was not really equipped enough to start trading. I so much enjoyed the simplicity in the style of how you presented this information to the audience much like myself. This Terminology part will help me a lot, i used to google term by term even the not so important ones.Thank you for this important information, well done!

    1. Thanks, Jordan.  Stay tuned because we will produce more content about trading in the next few months! 🙂

  6. I once joined an affiliate program for a forex robot software and these words made my head spin. Since there was no one explaining these terminologies, I ended up not making money at all. If only I have learned about what PIP means or lot sizes mean, then probably I have worked better with that affiliate program. To further my learning, I’d like to as, does your website has a dedicated page for a glossary of these terms?

    1. Hey Gomer!

      Thanks for your comment.  Well, these are actually the basic terms that anyone looking to trade currencies should be familiar with, but we’ll probably start a new set of terminologies in another post.

  7. These tips are really helpful for those who are actually into forex trading and those who are interested in going into it. I’m in a different line of business and wish to try something else as well. Well, forex trading seems like a good choice to try out, although I know little about it. I don’t know if you can be of assistance. 

    1. Hi, again Dane,

      Well, you can browse the rest of the contents of our site and check if some of our articles will be of help to you.

      All the best.

  8. Have I had  a foray into Forex ? Maybe a few years ago and foolishly, on my part, without any real understanding of the rudiments therein. I’m sure that when I’ve been reading through certain things, that these words have appeared and my brain has just brushed them aside.

    Needless to say, my knowledge and understanding was and is poor. I knew what a ‘broker’ is but that was it. Your explanations and descriptions with examples, were spot on. I may have to read through a couple more times just to get it to ‘sink’ in but it has to be said I now have a much better understanding.

    Having articles, like this one, are incredibly useful to those of us who might like to become involved with this type of trading, I am certainly not adverse to it, in fact, having done it once (poorly) I can see myself entering into this world again. I will be immersing myself further into your site before I do though.

  9. I have some experience in Forex trading, wish I had stumbled upon your post earlier as you have made those terminology so easy to understand! I spent a year doing it but didn’t find much success with it.

    I am wondering if you use technical analysis and Fibonacci numbers for your trading too? And if there is any trading platform that you recommends? 

    1. Hi Grace,

      Great to hear that!  Yes technical analysis is what we use for trading currencies since there are so many fundamental factors to consider which don’t necessarily affect how currencies move, but we do mix some critical fundamental data in some of our trades as well.

      For the trading platform, we have a review for Forex.com and City Index, please feel free to check it out.

      Thanks!

  10. I’m not really interested in trading forex until I read this article. I’ve been trading stocks for a while and it’s already been a headache for me, haha. I know practice makes perfect. And of course not forgetting the knowledge and the psychology. 

    I guess the forex market is more volatile than the stock market in general. I think it’s time to hunt more books and seminars. Meanwhile, your website is helping a lot. Thank you for making it available.

  11. This was the first article that actually made sense to me. Of the five the only one I clearly had an understanding of was Broker, but all the others were a bit foreign to me. Thank you for explaining Pips, Lot Sizes, Leverage and Spread. Now I will have more confidence in giving a more knowledgeable answer to a couple of friends of mine who have been recommending that I get involved with Forex Trading. I am bookmarking this so I can refer back to it.

  12. Recently I started to learn about Forex Trading and your post means a lot to me. I found your post highly uplifting and educational.

    For people like me who are on budget and can’t invest a lot of money Leverage option is a blessing and I really like it. The examples and clear explanation you have provided is super helpful and helped in my clear understanding. I can now explain to others and given an overview with examples on these 5 terminologies now. Thanks a lot!

    I can tell you I have taken some great insights from this post

    1. Thank you Paul!

      While leverage can help you speed up your profit-making, it can also do damage to your account.  Leverage is actually one of the reasons why forex traders lose money and most traders who do make money in FX trading are those who employ very little of it.

  13. As an investor that is just starting out with some extra cash looking for a broker this article has come at the right time.  I was searching these terms online to find out what the heck they were talking about in the prepaper work that they have sent me.  I was hoping to get some better info on the simple yet weird terms and this was a huge help.  Now I can go into the meeting and know a little more about my investing potentials and how it will all play out in the future.  Also another good note you have was to work with a company that is well known which I am going to be now and I think that is why they have sent the paperwork for me to read up on.  Thank you for all the great info.

    Douglas

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