Last update: July 2021
In this segment of Forex Trading 101, we are going to analyze the definitions of the market. While there are tons of similarities to stocks and futures trading, there are some differences.
Forex Definitions Video
Currency Quote
First currencies are not listed like stocks, they are traded in pairs. The currency pair has two currencies listed such as the EUR/USD or the USD/CAD. The first currency is the base currency. The base currency is what we make the initial transaction and is also what the chart represents.
The above chart is the EUR/USD. The chart is in a bearish downtrend which means the EUR is depreciating against the USD while the USD is appreciating against the EUR. The USD is the second currency listed in the currency pair and is called the counter or quote currency. Simply put, you are exchanging one currency for the other, if you buy the EUR, you sell the USD and if you sell the EUR, you are buying the USD. In essence, it really does not matter which one is listed first.
Leverage and Position Size
Currencies are highly leveraged tradable instruments. In the United States, they are leveraged at 50-1 which is one of the lowest in the world. This means if you place $1000 dollars into a trade, you actually control 50,000. Leverage can be a great way to reduce your cost dramatically, however, it can be a double edge sword. To control the risk of leverage we place less than 2% of available capital into short-term trades. You simply do not need to place more than that to effectively trade currencies. In longer-term trades such as carry trades, you can place up to 4%.
Contract Size
The total amount of money controlled in the trade is known as the contract size. This includes the amount borrowed as well as the amount placed in the trade. If we place $1000 into the trade, we borrow $49,000 and control a total of $50,000.
Lot Size
While you can place whatever you want into a currency trade, typically we think in terms of a Lot Size. This is similar to a contract in the options market or shares in a stock trade. There are three types of forex accounts: Micro, Mini, and Standard. Micro accounts trade in increments of 1000, Mini are traded in increments of 10000, and standard in increments of 100000. Typically most forex traders trade mini’s while larger accounts of 25000 or more might trade Standard lots sizes. Once again, you don’t have to place a ton in a trade to control a lot.
PIP
This stands for percentage in point or more commonly referred price interest point. The PIP is the lowest denomination a currency will trade and is typically the 4th decibel listed in the currency quote. In the EUR/USD it will be listed as 1.2539 with the 9 being the PIP. In the USD/JPY pair, it will be listed as 1.15 with the second decibel being the PIP. Outside the USD/JPY pair, all majors are traded in a 4th decibel. The value of each PIP is dependent on the contract value.
Tick value
The value of each PIP is relative to the contract value.
| Account | Contract Value | Position Size | Pip Value |
| 1) Micro: | 1000 | $20 | .10 cents |
| 2) Mini: | 10000 | $200 | $1 |
| 3) Standard: | 100000 | $2,000 | $10 |
To understand how this works, let’s analyze a swing trade on the USD/CHF:
- Long USD/CHF at .9583
- Stop Loss: .9520
- Target: .9900
| Contract Size | Position Size | At Target |
| 100,000 | $2,000 | 317 pips equal a gain of $3170 |
In the next segment of Forex Trading 101, I will look at the 24-hour cycle in the forex market.
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5 Replies to “Forex Trading 101: Definitions”
thanks for these segments, matt. i’m really looking forward to the next one!
you are welcome. I love forex trading and believe everyone has to learn what is happening in the currency market
Decibel or decimal? Gotta watch that spell checker. 🙂
Thanks Matt! That really helps demystify some of the basics of FOREX
I really appreciate this succinct description! Just what I needed to get started.
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