15 key terms to know in currency trading

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To learn about how trades happen on the currency markets and how to trade currency, it’s important to first get acquainted with some important terms used in relation to these trades. So, let’s get right to the point and begin at the basics. 

1. Currency pair

On the forex market, you cannot buy or sell a single currency as such. This is one of the most basic things to keep in mind when you trade in currency. Currencies are always traded in pairs. And quite obviously, each such set is known as a currency pair. An example of a currency pair would be the USD-INR pair. When you buy the USD-INR pair, you’re basically buying the dollar and selling the rupee. 

Whenever you place a trade in the currency market, you buy or sell a currency pair. And each pair has two currencies – a base currency and a quote currency. 

2. Base currency 

The base currency is the first currency that’s mentioned in a currency pair. For example, in the EUR-USD currency pair, the base currency is EUR.

3. Quote currency 

The quote currency is the second currency in a currency pair. For instance, in the EUR-USD currency pair, the quote currency is USD.

4. Exchange rate 

Exchange rate is the rate at which one currency is exchanged for another. So, it is the value of one currency expressed in terms of another currency. For instance, if USD-INR pair is 75.19, it means that 1 USD is worth Rs. 75.19.

When the exchange rate of a currency pair rises, it indicates that the base currency is gaining value against the quote currency. Consequently, it means that the quote currency is depreciating against the base currency. And conversely, when there is a decrease in the exchange rate, it implies the base currency is losing value against the quote currency, and that the quote currency is appreciating against the base currency. 

For instance, say the exchange rate for the USD-INR pair is 75.19 today. And tomorrow, it increases to 76. That means today, you can buy 1 USD with Rs. 75.19, but tomorrow, for the same 1 USD, you’ll need to pay Rs. 76. So, the USD has appreciated in value, and the INR has lost value. 

5. Cross rate 

An exchange rate that does not involve the official currency of the country in which the quote is published and used is known as the cross rate. For instance, let’s consider an example where you’re engaging in currency trading in India. Say you open your daily newspaper and find the following rates listed.

  1. GBP-EUR: 1.12
  2. GBP-JPY: 134.48
  3. EUR-JPY: 120.52
  4.  USD-INR: 75.24
  5. GBP-INR: 94.78

Here, the entries from 1 to 3 are all cross rates, since they do not mention the INR. But entries 4 and 5 are not cross rates, since they pertain to the official currency of India. Similarly, in the US, the EUR-JPY or the GBP-EUR exchange rates will be considered as cross rates. 

6. Pip

This is another key term to be aware of when you trade in currency. Technically speaking, a pip is basically short for Percentage in Point. It is the smallest unit of price for any foreign currency, and it generally refers to the digits that are added to or subtracted from the fourth decimal place of the rate. For example, 1 pip for the GBP-USD pair is equal to 0.0001. So, say the pair is currently trading at 1.26433. It then moves to 1.26443. This means it moved up by 1 pip. 

However, most yen pairs have their pip located at the second decimal place instead. So, for the USD-JPY pair, 1 pip would be 0.01.

7. Pipette

A pipette is one-tenth of a pip. In other words, it’s the fifth decimal place in the currency pair’s exchange rate (except for yen pairs, in which case it is the third decimal place). 

8. Bid price 

The bid price is essentially the price that the market is willing to pay for an asset. In the context of the currency markets, it is the price at which you can sell the base currency in a pair. 

9. Ask price

The ask price is essentially the price that the market is willing to sell an asset. In the context of the currency markets, it is the price at which you can buy the base currency in a pair. 

The bid and ask price are generally represented together, like this: 

USD-INR: 76.3475/76.3775

This means that the highest price a buyer in the market is willing to pay for the USD is Rs. 76.3475. But the lowest price a seller is willing to sell the USD for is Rs. 76.3775.

10. Spread

The difference between the bid price and the ask price is called the spread (or the bid-ask spread). The spread is an important concept to note when you trade in currency. In the above example, the spread comes out to be 0.30.

11. Long and short positions

This is an important area to note when you’re learning how to trade currency. Taking a long position essentially means that you buy a currency, since you expect its prices to rise in the future. It’s also referred to as going long. A short position, on the other hand, means that you sell a currency today, expecting its prices to fall in the future. So, you can square off your position by buying the currency back for a lower price at a later point. 

12. Lot 

Like derivatives, currencies are also traded in lots. A standard lot in the forex market is 1,00,000 units. However, there are also other options available, like mini lots (10,000 units), micro lots (1,000 units) and nano lots (100 units). 

13. Tick size

Tick size refers to the minimum amount of movement in the price of the currency pair. Knowing the tick size helps you take informed trading positions. When you know the tick size and the contract size of a currency pair, you know how much the price can move at any particular point in time. 

14. Final settlement day

This term refers to the trade day when your currency derivatives expire. Remember how for stock futures and options, the settlement or the expiry generally occurs on the last Thursday of each month? Just like that, for currency derivatives, the settlement day is generally the last working day of the month with regard to currency trading in India.

15. Settlement price 

This term basically points to the price that determines your profits or losses at settlement. Generally, the RBI reference rates are used as settlement prices. 

If you’ve taken a long position, you make a profit when the contract price is less than the settlement price. Conversely, if you’ve taken a short position, you make a profit when the settlement price is less than the contract price.

Wrapping up

Well, this should give you a fair idea of the key things to be aware of before you venture further into the currency markets and get into the details of how to trade currency. In the upcoming chapters, we’ll see what affects exchange rates and get to know some annual events that impact currency trading.

A quick recap

  • On the forex market, you cannot buy or sell a single currency as such. Currencies are always traded in pairs.
  • The base currency is the first currency that’s mentioned in a currency pair. 
  • The quote currency is the second currency in a currency pair.
  • Exchange rate is the rate at which one currency is exchanged for another. 
  • When the exchange rate of a currency pair rises, it indicates that the base currency is gaining value against the quote currency. Consequently, it means that the quote currency is depreciating against the base currency. 
  • When there is a decrease in the exchange rate, it implies the base currency is losing value against the quote currency, and that the quote currency is appreciating against the base currency. 
  • An exchange rate that does not involve the official currency of the country in which the quote is published and used is known as the cross rate.
  • A pip is the smallest unit of price for any foreign currency, and it generally refers to the digits that are added to or subtracted from the fourth decimal place of the rate.
  • A pipette is one-tenth of a pip.
  • The bid price is essentially the price that the market is willing to pay for an asset. 
  • The ask price is essentially the price that the market is willing to sell an asset. 
  • The difference between the bid price and the ask price is called the spread (or the bid-ask spread).
  • Taking a long position essentially means that you buy a currency, since you expect its prices to rise in the future. 
  • A short position, on the other hand, means that you sell a currency today, expecting its prices to fall in the future.
  • Tick size refers to the minimum amount of movement in the price of the currency pair.
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