Forex Investment and Currency Trading

Long / Short
When you first enter the Forex market you either go long by buying a currency or go short by selling a currency. When a currency is going up, you want to buy that currency so you go long. For example, if after researching currencies you learn that euros are expected to increase in value relative to the U.S. dollar, you would buy Euros and sell U.S. dollars.

The opposite is true if your research shows that a currency is expected to decrease in relative value. Then you would short the currency by selling it and buying one that is expected to rise.

Positions
A position is an open trade. Every time you take a position in the Forex market, it involves someone buying and selling each currency in the pair while someone else has to be willing to sell and buy the corresponding currencies.

You should have no trouble trading a currency pair as long as there is liquidity in the market for that pair. If you are trading the major currencies, you should be able to find a willing buyer or seller, called counterparty.

You will usually close out a position with your broker by reversing the original transaction. For example, if you bought Japanese yen with U.S. dollars, you would close the trade by selling Japanese yen for U.S. dollars.

Bid/Offer
When you see a quote for a currency pair, you will actually see two prices. One is the price at which the Forex broker or dealer is willing to sell the currency, which is called the offer or the ask. The other is the price at which the Forex market maker is willing to buy the currency, which is called the bid. This can also be viewed in terms of the trader, where the bid is the price at which a customer can sell, and the offer is the price at which a customer can buy. The bid price is always lower than the offer price, and is listed as the first price in a quote.

Spread
The spread is the difference in pips between the bid and the ask price for a currency. Forex brokers and dealers make money from the spread rather than with commissions, so you may notice a difference in the size of the spreads offered by different brokers, dealers, and banks.

Most brokers and dealers advertise that you can trade Forex commission-free because they make their money on the spread. Be sure you understand how the broker or dealer is being compensated before opening an account. Most spreads result in a cost of $10 to $40 per trade. Some Forex brokers hid additional fees in a wide spread, so review the spread carefully with your broker and be sure you understand your trading costs.

Exchange Rate
Exchange rates are given in terms of the base currency and pricing (or terms) currency. The base currency is always shown first in a currency pair. If you are buying the base currency, the exchange rate is the amount you would pay or receive depending on the value of the base currency in terms of the pricing currency. Conversely, if you are selling the base currency, the exchange rate is how much you’ll pay or receive for one unit of that currency.

For example, if the pair is shown as USD/JPY, the U.S. dollar is the base currency and the Japanese yen is the terms currency. So a quote of USD/JPY to sell USD for JPY at a price of 108.10 would mean for each U.S. dollar you could get 108.10 Japanese yen.

In Forex trading, the exchange rate will always be given as a pair when you are buying or selling because you are always selling one currency to buy another.

Pip
A pip is the pricing unit used in Forex trading. A pip is the smallest change in price that can be made in a currency. It is one unit of price change in the bid/ask price of a currency and is denoted by the last number behind the decimal point of the price. For example, if you receive a quote for the pair USD/JPY (U.S. dollar / Japanese yen) of 108.12/108.15, the spread is 3 pips.

Bull/Bear
When a market is described as a bull market, the general market is moving upward. If the bears are in control of a market, then the general market is moving downward.

Leverage
If you want to make money trading Forex, you’ll most likely need to borrow money because the price differences in currency, which are what you will make your profit or loss on, are only fractions of a cent. When you borrow money to trade, it is called leverage.

Leverage is the amount of money a Forex broker or dealer will lend you for your trading activities. A common leverage option is 100 to 1. That means for every unit you use of your own capital, the broker will lend you 100 units. So for an account with $5,000, you can trade up to $5000,000 of currency.

While it might sound exciting that you can trade half a million dollars for just $5,000, remember that while leverage does help you maximize your profits, it also increases your risk for substantial losses. When you’re first getting started in Forex, it’s a good idea to start much smaller.

To avoid taking on too much risk and to be sure you’ll have enough money to cover any losses, it’s a god idea to limit each trade to just 5 or 10 percent of your useable margin. That way if you do take a sizeable loss, you’ll have enough in your account to cover that loss without having to did deeper into your pockets.

Watch your useable margin as you trade. As you build your account, you’ll be able to buy more lots, but if you take it slowly and follow the basic rule of not putting more than 5 to 10 percent of your useable margin in one basket, you’ll minimize your risk. This will allow you to diversify your currency pairs and keep better control on your loss potential. You may also have a better chance of building your account with steady profits.

If your useable funds go into the negative, you will get a margin call. This means that if you don’t come up with the money required to maintain your account quickly, the positions you hold will be sold to cover your losses.

Most Forex dealers will give their clients between two and five days to cover a margin call. If you can not bring your account up to the specified minimum, your broker or dealer has the right to sell your positions to over your account balance. A margin call is not a bad thing – its purpose is to protect you and your capital. Be sure you read the fine print on your margin account contract. Also, discuss with your dealer how margin calls are handled and how much time you’ll have to answer a call.