An Introduction to Forex

Getting to grips with some basic terminology

First off, let’s deal with the broader terms you may come across –

According to the Corporate Finance Institute, foreign exchange (also referred to as forex or FX) is –

“the conversion of one currency into another at a specific rate known as the foreign exchange rate”

Elaborating on the above, we come to the term foreign exchange rate. An “exchange rate” according to Britannica is –

“the price of a country’s money in relation to another country’s money. An exchange rate is “fixed” when countries use gold or another agreed-upon standard, and each currency is worth a specific measure of the metal or other standard. An exchange rate is “floating” when supply and demand or speculation sets exchange rates (conversion units)”.

Or more simply put, it’s the rate at which you exchange one currency for another. That’s it. The exchange rate indicates how much of one currency you need if you want to purchase 1 unit of another currency. Simple as that.

The foreign exchange market, the marketplace – if you will – is the next stop.

Investopedia defines the FX market as –

“an over-the-counter (OTC) global marketplace that determines the exchange rate for currencies around the world. Participants in these markets can buy, sell, exchange, and speculate on the relative exchange rates of various currency pairs.”

And in quite simple terms, the above terms boil down to the following – foreign exchange is the exchanging of one country’s currency (let’s say the ZAR), for another country’s currency, (let’s say the USD) for a price (the exchange rate) which is determined by the Forex market.

With those main terms done and dusted, let’s move on to some other terminology you may come across –

• A Currency Pair, this may sound complicated but it essentially boils down to this – to trade in forex, you need a pair of currencies i.e. you are trading one currency for the other, with one currency being bought and the other one being sold. And that is a currency pair. Together these currencies make up an exchange rate.
• A Base Currency is the first currency in a currency pair, also referred to as the nominator (or top number). For example, when trading the USD/ZAR pair, the USD is the base currency.
• A Quote Currency is the second currency in a currency pair, also be referred to as the denominator (or bottom number). When trading the USD/ZAR, the ZAR is considered to be the quote currency.
• A PIP is generally the smallest increment or price change of a given exchange rate. Pips are used to measure the sometimes-incremental movement in a currency pair. Pip prices are not fixed and can change (moving up or down) depending on the timing of the trade or the amount that is being traded.
• A Lot refers to the minimum amount of currency that forex is usually traded in i.e. forex is traded in an amount called a lot.
• An Ask Price is also known as an offer price is the price a trader will buy a currency pair at.
• The Bid Price is the price a forex trader is willing to sell a currency pair for.
• A Basis Point is the term or measurement used to describe the lowest possible change in the price of forex.
• A Position doesn’t refer to how you sit or stand but rather the trade that you hold open during a certain period of time. A position may also be a long position wherein you purchase the base currency or a short position where you sell the base currency.
• A Stop Loss is a risk management tool that allows a position to be closed once it reaches a specific pre-set price. This can protect against further losses on an open position if prices continue in an unfavourable direction for the investor.
• Leverage – when trading in forex you may not always have the means to gain exposure to larger amounts of currency. By leveraging, your forex trader (like Kuda FX) lends you the money so that you can trade larger amounts with less capital. The amount that you are able to leverage will depend entirely on your broker and their flexibility. The leveraged amount can also be influenced by what type of account you open, what the leverage for that particular account type is, and how much leverage you may actually need.
• A Margin is the minimum amount of funds, expressed as a percentage, that you will need if you want to open a position and keep it open.
• A Margin Call is when a forex dealer requests additional funds or other collateral on a position that is not moving in the favour of the investor.
• Equity is quite simply the total amount of currency in your trading account, taking into account all of your profits and losses.
• Gapping occurs when the opening price of a currency is significantly above or below the previous day’s close. With the kicker being that there was no trading activity in between the close and the opening of markets. This means that a stop loss order could be filled at a price different from the pre-set price.
• A Commodity is a raw material or agricultural product that can be bought and sold, including oil, coffee, wheat, copper and most definitely gold (be mindful of gold however as it can also be considered a currency. Remember, gold is not a consumable like some other commodities. In other words, once gold is mined it remains in the world, it doesn’t get “used up”. Which is why some define gold as a type of currency. Read here for more info on this topic).

There are many more terms and buzz words used in the forex trade. But we believe the ones listed above should cover most of what you need to know.

However, should there be any other term that you come across, please feel free to get in touch with us and we would be happy to explain the meaning behind the term or how it applies to you or your investment.

Kuda FX has you covered!