Master the 7 Terms to Take the Next Step in Trading

If you don't take your time to understand some of the jargon in forex trading before taking a trade, you are only a step away from being thrown off the trading market, irrespective of whether you an existing trader or a newbie who's just learning the art. But, how many traders actually understand the significance of these terms? Like CFD trading, forex trading has its own unique nuances and once you are able to get your head around them, you will be well on your merry way to developing your trading skillset and confidence.

PIP

Percentage in point or PIP as it is known for short is a measure for exchange rate movement. The pip is a numerical measure of profit and loss, and a single pip is equal to $0.0001 for U.S.-dollar related currency pairs. When your trade is positive in pips, you are making profits, but when it is negative in pips, it means your trade is going underwater.

For instance, if you have a USD/EUR direct quote of 0.7725, it means that for US$1, you can buy about 0.7725 euros. If there was a one pip increase in this quote to 0.7726, the value of the US dollar would increase relative to the euro, as $1 would allow you to purchase slightly more euros. 

LEVERAGE

Leverage involves borrowing an amount of money to trade. Simply put, it is a 'borrowed capital' that allows traders to trade much bigger volumes than they would, using only their own small amount of capital. Leverage is the ratio that defines the amount of loan "margin," that a trader is allowed to use to gain access to larger sums of trading capital.

Leverage can, without a doubt, raise your profits but at the same time increase your losses too. So, you have to use it wisely. The concept of leverage is applicable to all forms of trading and if you understand it well while trading forex, you can take advantage of it when you want to cross into other types of trading like CFD. But, that is not to say you have the liberty to discard the possibility of working with CFD brokers. In forex, for instance, say two traders have $10,000 and they both wish to use $2,000 on one trade as margin.

The first trader has account leverage of 10:1 and the second trader has an account leverage of 100:1. The exposure they both have differed because of the difference in their account leverage ratios, with the former having $20,000 and the later having $200,000.

MARGIN

This is also known as your deposit, and it is the number of funds in your account required to be placed to open a trade position. It is a function of the desired notional exposure to a specific trading market and the leverage ratio. Margin is so crucial to your trades and you cannot afford to make the wrong ones because once a position has been established and an initial margin has been placed, you'll be accruing a real-time loss or profit. Margin can either make or mar your trading positions. In fact, if your equity falls below a specific level then you may receive a margin call. Once you receive a margin call, you will need to fund your account to support any existing open positions you have. Failure to fund your account by a set time will result in the automatic closure of your open positions.

SLIPPAGE

A stop-loss is an excellent risk management tool and it allows you to effectively understand how much risk you are taking on in any particular trade. It is crucial to understand that a stop-loss is a trigger point and a market order. What it signifies is that: if the market price falls through your specified stop-loss level, a market order should be activated to close your trading position at the prevailing market price. However, if the market is trading at a level that is different from the specified stop-loss level at that precise moment of execution, then the stop may be filled at a worse or better price. This event is called 'slippage.' Slippage is influenced by volatility and liquidity, and it is highly advisable for a trader to consider the possibility of slippage when going into a period where markets are closed such as public holidays or weekends.

DEMO

A demo account is a practice account that allows traders to understand the forex platform, the charting, the market environment, and execution all while trading with virtual funds. Trading in a demo account is the perfect way for any trader to gain confidence in your ability to manage risk, understand position sizing, and get used to the nuances of the forex market. Every trader, both new and existing, should always try out a demo account as it equips you with so much to go on the live market. 

Analysis

There are two crucial disciplines that should sit at the top of your trading plans and methodologies. Some traders usually look at one in isolation, but, combining these two disciplines can be exceptionally powerful.

• Technical analysis

The first discipline is a technical analysis that involves the use of charts to better comprehend the rudiments of the market and ascertain probability as well as risk-to-reward-ratio trade-off. Along with price action analysis, technical analysis can be a very potent tool to predict future market events and moves.

• Fundamental analysis

This involves a trader's ability to interpret news flow and how new market information affects market prices. Think of it like this: fundamental traders aren't just concerned about trades moving from position X to position Y, but want to understand what caused the move and what it will take to move to another position Z. This is the type of information you get from fundamental analysis.