Understanding Forex Trading Terms

Let’s get right to it… 

Understanding forex trading terms is easy!

The first question is, what are currency pairs?

It’s simple. 

Whether you’re buying or selling currencies, you’re trading in pairs. 

For example, say you want to trade the AUD/USD. That’s the Aussie dollar and the US dollar. Buying the AUD/USD means that you are buying Aussie dollars and selling US dollars. Simply, you’re bullish on the Aussie dollar against the US dollar. If you think the Aussie dollar is weaker than the US dollar, you would want to sell the AUD/USD. 

That’s how forex markets work. 

You trade one currency against another. The question is: Which do you think is the strongest currency? People most often trade these major currency pairs, since they represent the world’s major economies:

  • EUR/USD (euro against US dollar)
  • USD/JPY (US dollar against Japanese yen)
  • GBP/USD (British pound against US dollar) 
  • USD/CHF (US dollar against Swiss franc)

Reading forex quotes

Imagine the exchange rate for AUD/USD is 0.75. This means that one Aussie dollar is worth 75 US cents. (You can find live currency quotes, here). 

It might sound confusing. 

But it’s quite simple. 

Here, the first currency (AUD) represents a unit of that currency. The exchange rate (0.75) shows how much first currency (AUD) could buy a unit of the second currency (USD).

The AUD/USD exchange rate shows how much US dollars you would get from one Aussie dollar. Want to know how many Aussie dollars you’d need to buy one US dollar? Just invert the exchange rate. 

The formula is: 1 / exchange rate.

Using this formula for our example, 1 / 0.75 = 1.33. You would need to spend 1.33 Aussie dollars to buy 1 US dollar. This would also show the rate of exchange for the USD/AUD. The two currencies have their positions switched around!

How to read forex pairs

In a pair, the ‘base’ currency (AUD) is the first listed currency. The second is the ‘quote’ currency (USD).

The base currency is what you’re speculating on when trading forex. 

When buying the AUD/USD, it means that you’re taking a bullish view on AUD against the USD. When short selling the AUD/USD, it means that you’re taking a bearish view on AUD against the USD. 

Think about what you’re speculating on! 

You’re speculating on the first (base) currency in the pair. If you think the base currency is undervalued against the quote currency, you would buy the pair. If you think the base currency is overvalued against the quote currency, you would sell the pair.

All currencies quoted are in pairs.

Traders often get confused with currency pairs. So, if you want to solidify you’re knowledge, let’s dive a little deeper to futher your understanding of forex trading terms.   

What’s the difference between EUR/GBP and GBP/EUR?

It’s simple.

How to read forex pairs simply

If you’re trading EUR/GBP, the front currency is the one you’re looking at trading. If you believe the euro will INCREASE against the pound, you would buy EUR/GBP. On the flip side, if you believe the euro will DECREASE against the pound, you would sell EUR/GBP. 

If you’re trading GBP/EUR, on the other hand, the front currency is the one you’re trading. If you believe the pound will INCREASE against the euro, you would buy GBP/EUR. On the flip side, if you believe the pound will DECREASE against the euro, you would sell GBP/EUR. 

In another example, you might be from the US and be bullish (positive) on Europe. If so, how would you take advantage of this trade? You could either buy the euro (i.e. buy EUR/USD) or sell the US dollar (i.e. sell USD/EUR). 

Here’s a visual example from forexfactorz.com: 

I hope you get the idea. 

Forex also has unique nicknames for currency pairs. 

It’s common to use nicknames to refer to pairs in forex trading. Commonly traded currencies have a nickname to simplify how we refer to and interact with them:

  • EUR / USD – Fiber
  • USD / JPY – Yen
  • GBP / USD – Cable
  • USD / CAD – Loonie
  • AUD / USD – Aussie
  • NZD / USD – Kiwi
  • USD / CHF – Swissy

Long and short

You have two choices when trading in forex. You can enter a long or short position. Long means buy, short means sell. 

Many people come from stocks to forex. When they buy stocks, they will try to earn money by buying low and selling higher. 

It’s the same in forex. 

Just that you’re betting on the economies. 

In forex, you can buy and sell easily, as well as earn good money. You can make equal profits when the price moves lower or higher. Looking for high-probability trades is the name of the game. Most of the time, prices move much quicker when going lower than when going higher. 

Traders can sell high and buy low in forex. Here, they can earn the same way as selling low and buying high. So, if traders see markets crashing, they can make money.

This gives traders more choices.

Types of forex orders

But how do you buy and sell? 

This is just as easy as trading in the stock market. 

If you want to make a forex transaction, it means that you need to use an order type. A few order types are available for position entry. Many brokers provide them. Take note that many traders will not enter at market order. Instead, they may set pending orders at set level to confirm the price.

Digging deeper into forex orders

Here are some of the more common order types:

    • Market order ― If you want to buy or sell and want instant execution, trade using market orders. Usually when placing a market order, it will be done at the current market price. But, during periods of high volatility, market orders might not be executed at the price you intended to buy/sell because markets will be moving fast.
    • Buy stop order ― If you want to buy when prices are above current market price, set a buy stop order. These types of orders are favoured when buying while above resistance levels.
    • Sell stop order ― If you want to buy when prices are below current market price, set a sell stop order. These types of orders are favoured when buying while below support levels.
    • Buy limit order ― If you want to buy at a predetermined price level, set a buy limit order. For example, if you believe the price is too high and will fall lower, you might set a buy limit order below the market price. 
    • Sell limit order ― If you want to buy at a predetermined price level, set a sell limit order. For example, if you believe the price is too low and will rise higher, you might set a sell limit order below the market price. This would happen if you’re thinking of shorting the market and think the price isn’t high enough yet. 
    • Stop loss order ― If you want to protect your losses as a way of risk management, you’ll set a stop loss order below your entry price. 
    • Take profit order ― If you want to capture a specific profit above your entry price, you’ll set a take order profit below your entry price. 

The bid and ask is key part to understanding forex trading terms

If your understanding forex trading terms now.

The next part is essential to understand. 

You’ll always see a ‘bid’ (sell) and an ‘ask’ (buy) when trading forex. Some platforms make it easier and use just ‘sell’ and ‘buy’:

A market order is simply buying or selling the market price. There are sell and buy (or bid and ask) buttons on every platform. If you were to set a ‘buy limit order’, similar to the ‘sell limit order’, the limit order is seen on top of the buy and sell buttons: 

My platform is straightforward. On other platforms, you might see the limit order tab under the ‘bid’ price and ‘ask’ price. But most are simple to navigate. 

Taking your forex understanding to another level

Most forex educators say the ‘bid’ price is the sell price and the ‘ask’ price is the buy price: 

This is technically true. 

For example, if you want to buy and sell, you’ll simply get the current market price. But if you’re trading limit orders ― waiting for price to come to you ― it’s technically the opposite: 

The ‘buy’ (ask) price is actually the REAL sell side ― although you won’t see it behind the current market buy price. That’s where sellers are lining up to sell for various ‘asking’ prices. If you wanted to buy ‘at market’, you would get the ‘ask’ price because that’s the lowest price a seller is willing to sell his currency for. 

It’s the same thing flipped around… 

The ‘sell’ (bid) price is actually the REAL sell side ― although you won’t see it behind the current market sell price. If you wanted to sell ‘at market’, you would get the ‘bid’ price because that’s the highest price a buyer is willing to buy his currency for.

If you don’t understand, don’t worry. But it’s worth explaining why some people get confused ― especially if you’re struggling to understand why bid means sell, and ask means buy. It’s counterintuitive, so I’ve explained it. But don’t let theory confuse you. Your platform makes buying and selling very simple for market, limit and stop loss orders. 

The key to understanding forex trading terms – Paying the spread

Moving on, the difference between the ‘bid’ and the ‘ask’ is known as the spread. This is how forex brokers get paid.

For example, when you buy or sell a stock on the share market, you’ll pay commission. In forex, you won’t have to pay commission if you don’t want to. Forex doesn’t tend to have commissions. You will have to pay the spread to buy and sell. 

Brokers will offer you two options to choose from when you open an account.

The first account is often the standard account. It offers slightly larger spreads, but without commissions. The other account has tighter spreads. While it offers tighter spreads, day traders and scalpers prefer to pay commission. On the other hand, short- and long-term players tend to just pay the spread. 

Every trader needs to decide which type of account to use.

Do the maths and see what’s better for you. 

Your ‘Start With Forex’ takeaway to understanding forex trading terms

We told you that understanding forex trading terms was easy! If you remember one thing from this lesson, let it be this ― you’re speculating on the first (base) currency in the pair. The base currency is the first currency in the pair. People often get confused when reading currency pairs. 

Don’t let it bother you. 

Know that the first currency in the pair is the currency you’re speculating on in forex…

Then you just need to analyse whether to buy or sell, and place your position. 

Professional traders tend to use limit orders. But it really doesn’t matter in forex because it’s the world’s most liquid market. Rule of thumb: Watch the spread. If it’s really wide, it would be better using a limit order. If the spread’s tight (small), it doesn’t really make a difference. 

It’s one thing learning how to trade. But if you don’t know any history about the forex market, you’re doomed to repeat the mistakes of the past. In the next forex lesson, we’ll uncover some of the major events through time. Most people don’t know this stuff, as you will see. So, if you’re ready to learn the history of forex, click here

To your trading success,
Start With Forex 

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Quiz

Lesson Two: Understanding Forex Trading Terms

 

Currencies are traded in:

Correct! Wrong!

It is what you are speculating on when trading forex:

Correct! Wrong!

The nickname used to refer to New Zealand Dollar and the US Dollar currency pair is:

Correct! Wrong!

The difference between trading stocks and trading currencies is:

Correct! Wrong!

If you want to protect your losses as a way of risk management, you set this type of order below your entry price:

Correct! Wrong!