Foreign Exchange Glossary of Terms

Foreign Exchange Glossary of Terms

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One aspect of foreign exchange involves understanding the key terminology so that you can make an informed decision. This can act as a source of confusion for people who are new to the world of currency markets.

Below, you’ll find a glossary of FX terms with simple definitions, many of which are enhanced with examples that shed more light on the meaning of a word or phrase. Bookmark this page to ensure it’s in easy reach when required.

Asset: In a general sense, an asset is an economic resource that individuals, collectives, corporations, and other organizations can control or own. This may be done to turn a profit or for a benefit in the future. In FX, the term is frequently used to refer to a currency or currency pair.

Before online trading grew in popularity, assets were investments, and trader and investors bought them in the hope that their value would increase. Now, the use of assets to determine the prices of derivative products has also led to them being used to determine the profit or loss from CFD and other derivative trades. Currencies, commodities, bonds, shares, options, indices, and ETPs are examples of underlying assets.

Base Currency: The base currency is the first currency listed in an FX pair quotation. For example, GBP is the base currency in the GBP/EUR pairing. One foreign currency is always quoted in relation to another on the FX market, as you will purchase one currency and sell the other.

The currency that appears next to the base currency is known as the counter or quote currency. The amount that appears on a chart is the counter currency, and you will need to spend that amount of that currency to purchase a single unit of the base currency. For example, if GBP/EUR price is 1.16, you will 1.16 euro to buy one pound sterling.

Currency Appreciation: Currency appreciation refers to the increase in value of one currency relative to the other. A single unit of the strengthened currency would cost more to buy. When this happens, a currency is said to have strengthened against, or in relation to, another currency.

For example, in a GBP/EUR currency pairing, GBP is the base currency and EUR is the quote currency. If the price is listed as 1.16, it means you will pay EUR 1.16 for GBP 1.00. If the quote price increase to 1.25, you would say the pound has appreciated in value next to the euro, as you would need to spend EUR 1.25 to buy GBP 1.00.

Currency Futures: A currency future is a contract in which you will find the buying or selling price of a currency, as well as the specified date of the exchange. The counterparty that holds the contract when the expiration date is reached is legally obligated to receive the currency at the price and on the date specified in the contract.

Futures prices differ from spot prices in that they’re based on a future potential market price, while spot prices are defined by current market values. Currency futures are highly regulated and with legally binding terms and conditions, and they’re traded on an exchange. Currency forwards are customised according to what is required by both parties: they’re privately negotiated, and they’re traded over the counter.

Currency Pair: A currency pair is at the core of every FX transaction, as that is what’s being traded – one currency for another. Most pairs fall into one of three categories, namely major, minor, or exotic currency pairs. GBP/USD is an example of a major currency pair.

The first of the currencies listed in the pair is known as the base currency, and the second is known as the quote or counter currency. In the example above, GBP is the base currency and USD is the counter currency. The price listed with a pair is the amount of counter currency you will need to buy one unit of the base currency.

Drawdown: A drawdown occurs when a customer utilises part of their booked Forward Contract. A portion of their flexible forward contract is thus executed.

Exchange Rate: The exchange rate indicates the cost of trading one currency for another. For example, during the morning of 9 June 2021, the GBP/Euro exchange rate was £1 = €1.16. The term ‘foreign exchange’ refers to the trading of those currencies.

The foreign exchange market, which sees trillions of dollars traded daily, is the world’s biggest and most liquid market, and it determines the exchange rate or value of most major currencies. Unlike a stock exchange in a particular location, the FX market is an electronic network of traders, brokers, banks, and other institutions.

Floating Exchange Rate: The term ‘floating exchange rate’ refers to the setting of a country’s currency price by the foreign exchange market. The rate is based on supply and demand, and it is relative to the supply and demand of other currencies.

Long-term changes to the currency price are a reflection of differences in countries’ interest rates and of the relative strength of the economy. Short-term changes are indicators of everyday supply and demand for the currency, speculation, and disasters. The price will rise if demand outpaces supply, and it will fall if supply overtakes demand. Most major global currencies have a floating exchange rate.

Forex Chart: An FX or forex chart is a graphic representation of the historical behaviour of two currency pairs’ relative price movements over various time periods. Charts are valuable sources of information for technical analysts who wish to identify patterns or trends that could indicate entry points, continuations, reversals, and exits.

Forex charts are available in bar, candlestick, and line formats. The time-period is usually indicated by the x-axis (horizontal) and the exchange rate on the y-axis (vertical). Most platforms’ charting software provides a range of timeframes, from tick data to yearly data. You can find a forex chart on the moneycorp site.

Forex Scalping: Forex scalping refers to a style of day trading that sees traders buy or sell currency pairs with a short holding time in the hope of making several quick profits. The holding times vary from a few seconds to a few minutes. The idea is to take advantage of the small price movements that happen throughout the day by making a large number of those fast trades.

Usually in the region of 5 to 20 pips per trade, the gains of forex scalping are small. However, traders can enlarge the position size to enhance their profits.

Forex Signal System: A forex signal system is a set of analyses based on forex charting tools and technical analysis, or on events in the news. Traders use forex signal systems to decide whether to buy or sell a currency pair.

You can use a manual or an automated system. A manual system sees you remain at your computer, look for signals, and analyse the data with a view to buying or selling. If you use an automated system, you will need to ‘teach’ the software to find and interpret signals.

Forex Spot Rate: The prevailing quote for a currency pair given by a broker is known as the forex spot rate. When most traders trade with an online broker, they use the spot rate, which is the current rate at which they can buy or sell a currency. The forex spot rate is what most individual forex trades are based on. The rates are published in continuous quotes in real-time by the group of banks that trade the interbank rate. Brokers then publish those rates around the world.

With a daily turnover of more than $5 trillion, the global forex spot market is nominally bigger than the bond and equity markets.

Forward Contract: A forward contract is a customised contract between two parties to buy or sell currency or to make an international payment at a set exchange rate in the future. Setting the rate offers protection from fluctuations in the market, although that can be a disadvantage if the actual rate moves in your favour.

A forward contract may also be referred to as a deliverable forward or a currency forward. These contracts are particularly suitable for use as part of a hedging strategy that can decrease your business’ currency exposure. Businesses that need to pay large invoices in other countries on a regular basis may also find forward contracts helpful.

Hedging: Hedging refers to protecting your position in a currency pair from unfavourable moves. This can grant short-term protection against volatility in currency markets, and it usually takes the form of one of two strategies:

The first strategy is to take the opposite position with the same currency pair. For example, if you hold GBP/EUR long, you’ll short the same amount in EUR/GBP. The second is to use other FX options, such as buying puts option contracts if you hold a long position in a currency or buying call option contracts if you are short a currency pair.

Limit Order: A limit order is an order to buy or sell a currency at a specified price or better. The market must trade at that price or better for the order to be fulfilled.

A limit-buy order determines that a currency pair will be bought at the market price or lower, if or when the market reaches or drops lower than that price. A limit-sell order determines that a currency pair will be sold at the market price or higher, if or when the market reaches or exceeds that price.

Liquidity: Liquidity, or depth of market (DOM), is the volume of the supply and demand for assets that can be traded. It refers to the number of active or open buying and selling orders, over a wide range of prices, for a specific currency. The market deepens as the number of active orders increases. Some traders refer to DOM data as the “order book.” You can use real-time DOM data to predict the direction in which a currency’s price will move. DOM displays online include the complete list of pending buy and sell orders as well as the sizes of those trades.

Lot: This refers to a unit of measurement used for transaction amounts. Just as eggs are usually sold by the dozen, so currencies are usually traded in amounts known as lots.

There are 100,000 units of base currency in a standard lot in an FX trade, but there are several other lot sizes in use. They include nano-lots, micro-lots, and mini-lots. There are 100 units of base currency in a nano-lot, 1,000 units in a micro-lot, and 10,000 units in a mini-lot. In the interbank market, a standard lot consists of 1 million units of base currency.

Liquidity: Liquidity is a currency pair’s ability to be bought or sold on demand. Major currency pair trading is a very liquid market, but it is important to note that your trading is based on the available liquidity of the financial institutions which get you in or out of your chosen currency pair.

Not all currency pairs have the same liquidity level, neither are all pairs liquid. The liquidity level depends on whether the pair is major, minor, or exotic, with major pairs being the most liquid, and exotic pairs being the least. Emerging market currencies are included in exotic pairs.

Long Position: In foreign exchange, taking a long position means buying a currency with the expectation that the market price will increase and you will make a profit when you sell it. You go long on the currency that you purchase (the base currency) and short on the currency you sell (the quote currency).

For example, if you think the euro will strengthen against pound sterling, you will purchase euro with sterling and hold them in the hope of selling them when their value peaks. In this trade, you will have gone long EUR/GBP because you bought euro and sold pound sterling.

Margin Call: A margin call is a notification that the value of one or more of the securities in your margin account has decreased. If you receive a margin call, you will need to deposit money into your margin account in order to satisfy the minimum capital requirements.

A margin account usually contains securities purchased with a combination of the investor’s money and money they borrowed from their broker. The minimum value threshold is known as the maintenance margin. A margin call will be made as soon as the balance drops below that amount.

Market Order: A market order is an agreement to purchase a currency at your choice of set exchange rate. However, the trade will be processed only if or when that rate is reached. Market orders offer a few advantages, such as not being concerned about currency exposure, no need to watch the market, and a satisfactory exchange rate.

The two types of market orders include stop loss and limit orders. Stop loss orders are used when you think that an upward trend in the exchange rate will end and that it will then move against you. Limit orders are used when you think an upward trend in the exchange rate will continue.

Open Position: An open position is an FX trade that has yet to be closed. Such a trade is still able to turn a profit or incur a loss – either way, profits and losses are realised when the position closes and the trade ceases to be open or active. If you purchase a currency pair with the expectation that its value will increase, the position’s known as an opened buy position. If you sell a currency pair with the expectation that its value will decrease, you take a sell position.

Some short-term traders do ‘round-trip’ trades in which they open and close positions within a few seconds or minutes.

Quote Currency: The quote currency is the second currency in a direct or indirect currency pair. It’s also known as the counter currency. The quote currency is listed after the base currency, the value of which it determines, in an exchange rate quote.

The foreign currency is the quote currency in a direct quote, but the domestic currency is the quote currency in an indirect quote. The exchange rate of the currency pair indicates how much quote currency you need to sell or buy to buy or sell a single unit of the base currency.

Risk Management: Foreign exchange is not without risk, and the greater the risk, the greater the chance of a bigger profit – and of a sizeable loss. Risk management comprises the strategies and individual actions that traders take in the hope of maximising profits while minimising losses.

For some traders, risk management includes establishing the right position size, making use of stop losses, and keeping their emotions under control whether entering or exiting a position. Trading FX without a reliable risk management strategy is similar to gambling in a casino. Implementing risk management, however, is one of the keys to profitable trading.

Spot Contract: A spot contract is a contract is an agreement to buy and sell a foreign currency at a specified rate within 48 hours of entering into the contract. The rate often is the current market exchange rate, and delivery of the currency often is immediate.

A spot contract is drawn up after the currency pairing, the amount, and the exchange rate have been confirmed. The date on which you agree to the contract is the date of trade, and the date on which the funds are exchanged and deposited into the chosen account is the settlement date.

Spread: This is the profit taken by a broker or bank, and it is calculated by taking the difference between the rate that the broker/bank receives and the rate that they pass on to their clients.

Soft Currency: A currency with a fluctuating value that is mostly lower than other currencies’ values due to lesser demand for that currency is known as a soft currency. The lack of demand usually is due to economic uncertainty or political issues in the country.

The currencies of most developing countries are regarded as weak. The situation is not helped by the governments of many of those countries, as they peg their currency to a major currency such as the US dollar. The result is an exchange rate that is too high, values that are unfavourable for investors, and less demand for the currency.

Stop-Loss Order: A stop-loss order allows you to specify the minimum exchange rate at which you would be willing to trade one currency for another. To reiterate, the trade will be processed only if and/or when the desired rate is achieved.

One of the benefits of stop-loss orders is that they can limit investors’ losses on positions. The order also offers you the possibility of receiving a rate that you think is satisfactory, and it means you don’t need to be concerned about currency exposure. Monitoring the market also isn’t necessary when you have a stop-loss order.

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