Under this barbaric term hides the abbreviation of "Foreign exchange" (For-Ex), which designates the foreign exchange market, or the "currency exchange" to make it simpler.
We have all dealt with Forex in in one way or the other while traveling abroad, trading currencies, and we have all also noticed that exchange rates fluctuate.
It is precisely these variations that forex traders take advantage of.
Forex is therefore the virtual place of exchange for currencies, the value of which fluctuates constantly, 5 days a week and 24 hours a day (forex is indeed the only market that is open 24 hours a day , and it is therefore possible to trade at nights).
Before tackling forex trading itself, and the techniques that will allow you to trade successfully, you must understand the general functioning of this market, its specificities, and become familiar with the vocabulary used.
We will therefore review the main terms used by forex traders here, explaining in detail the essential concepts in currency trading.
Special feature 1: Currencies are quoted in "pairs"
Unlike other financial assets, currencies are quoted in pairs. It is always the value of one currency expressed in another currency.
Therefore, whether we buy or sell a currency pair, we are betting on the rise of one currency, but also simultaneously on the fall of the other currency.
Example
When you buy EUR / USD, you are betting on the rise of the Euro against the Dollar, which means that you are also betting on the fall of the Dollar against the Euro. The motivations for buying EUR / USD can therefore result from either a bullish opinion on the Euro, or a bearish opinion on the Dollar.
Conversely, when we sell EUR / USD, we are betting on a fall in the euro against the dollar, which implies that we are also betting on the rise in the dollar against the euro. The motivations for selling EUR / USD can therefore result from either a bearish opinion on the euro, or a bullish opinion on the dollar.
Special feature 2: You can bet on the fall of a currency pair as easily as on the rise
We have just spoken of "selling" EUR / USD, which perhaps implies that you must have bought some beforehand. This is not the case, however. In forex, it is possible to take a short position on a currency pair, without having "in stock" this currency pair.
This mechanism is known in the equity markets as “short selling”. It is actually a "game of engagement". By taking a short position, you are agreeing to 'supply' a currency pair at the time of your entry, when you want to close the position.
Therefore, if you take a short position in EUR / USD at 1.20, and close it at 1.10, it is like buying at 1.10 what you previously committed to sell at 1.20, the difference being your profit.
However, on the trading platform, betting on the downside comes down to clicking “sell” instead of “buy”, it’s that simple!
Special feature 3: Performances are counted in pips and quantities in lots
Forex traders calculate changes in “pips”, not percentages, and currencies are bought in “lots”.
1 pip is equivalent to the last decimal place of a currency quote:
Example
EUR / USD goes from 1.2750 to 1.2800, it is said that it gained "50 pips".
This method of calculating variations is in fact preferred in forex trading because in percentages, currency variations are difficult to read due to their low nominal volatility.
For example, when the Euro goes from 1.2545 to 1.2565, the change is only 0.16% (up 20 pips).
You should also know that currencies are bought in batches. Most brokers offer lots of different sizes, ranging from 1000 (micro lot) to 100,000 units (standard lot).
It is also easier to calculate profit and loss with pips, because we know the value of 1 pip depending on the size of the lot on which we are trading.
Example: EUR / USD
-Lot of 1000 units: 1 pip = 0.1 USD
-Lot of 10,000 units: 1 pip = 1 USD
-Lot of 100,000 units: 1 pip = 10 USD
So, when we won 20 pips by having traded a lot of 1000 units, we won 2 dollars, 20 dollars with a lot of 10,000 units, and 200 dollars with a lot of 100,000 units.
Special feature 4: You can bet on amounts much greater than your capital thanks to the leverage effect
We have just seen that the minimum lots in forex are lots of 1000 units, which is 1000 dollars as far as EUR / USD is concerned, but that does not mean that you must have this amount in your account to take the position. .
This is where the famous "leverage" comes in, one of the main advantages of forex trading.
Put simply, leverage allows you to have more money to invest in forex than you have in your trading account.
For example, a leverage of 100 means that you can invest in amounts 100 times greater than what you deposited in your trading account.
With 1000 dollars, you can therefore invest on an amount of 100,000 dollars, if you have a leverage of 100.
This is indeed where one of the main advantages of Forex lies, and it is thanks to the leverage effect that Forex is a market that can (on paper) make you rich overnight, even with a minimal initial stake (extremely rare in reality, but theoretically possible).
It is also because of the very important leverage that forex offers that it is considered an ultra-speculative market and very risky for the novice traders.
Example
With a credited account of 1000 dollars and a leverage of 100 (brokers generally offer 50 to 500), one can invest in an amount of 100,000 dollars (1000 dollars x 100 leverage).
Special feature 5: Trading on margin
The margin designates the amount to be “mobilized” to carry out an operation. Basically, this is the amount of your prize divided by the leverage.
When you buy a $ 1000 lot with a leverage of 100, you only raise $ 10. In other words, you are only raising a hundredth of the size of your trade ($ 100 / leverage 100). This 10 dollars used is called the "margin".
A small calculation will be more meaningful:
- Purchase of a lot of 10,000 units when EUR / USD is at 1.3000
- Leverage of 100
- Capital raised: 10,000/100 = 100 dollars (you must have at least 100 dollars on your trading account to take this position).
- If EUR / USD goes from 1.3000 to 1.3100 (current variation in one day), the gain is 100 pips
- 100 pips X 1 dollar (value of 1 pip on a lot of 10,000 EUR / USD units) = 100 dollars
Having actually invested 100 dollars, the final gain is therefore 100 dollars, which represents a performance of + 100% compared to your real investment (the margin mobilized).
Knowing that Forex is a very volatile market, and that it is common to see daily variations of more than 100 pips, we quickly understand that gains can accumulate at an extraordinary speed (just like losses for that matter ... ).
Special feature 6: The spread instead of transaction fees
The quote price of a currency pair at a specific time differs depending on the direction of the transaction: Buy or sell.
The difference between the Buy Price (Ask) and the Sell Price (Bid) is called the Spread.
In this example, we therefore say that the spread of the EUR / USD pair is 1 pip.
In practice, this means that if you place a buy and then close that position immediately without the neck moving, you lose 1 pip, just as if you place a sell and close it immediately.
It also means that in the context of a buy, your position starts to be profitable after an increase of 1 pip (and after a decrease of 1 pip if you have decided to sell).
This difference, which is called the spread, constitutes the remuneration of your broker.
At FXCM for example, the spread on EUR / USD regularly drops below 1 pips. But beware, some brokers do not hesitate to apply a spread of 3 pips! Remember, the lower the spread, the better!
In the end, a particular market, but which offers many advantages
Even if some of these concepts are found in other markets, we understand that Forex has its specificities, which are all advantages.
This can impress novice traders, but you get used to it very quickly, and if all newbie traders do not necessarily become good traders, all very quickly manage to understand and master these concepts, this vocabulary and how it works, to be able to start get to the heart of the matter and start trading online on a real account.
So that is basically the fundamentals of forex trading and its vocabularies, in the next article we will look at how to read currency pairs and charts.
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