Before you can walk the walk you need to be able to talk the talk and just like in any other profession trading has a Tommy gun loaded with jargon, for that reason the basic terms have been included in this section. Should you forget some of the definitions as you are reading along the way, feel free to come back to jog your memory.
- Spread: With regard to an asset or security this is defined as the difference between the bid and ask price (or sell quote and buy quote), which gives the profit for currency market dealers.
Spread = Offer price – Bid price.
Example: Jane asked for a quote for the Euro/USD and her broker furnished her with an offer of 1.26724 and a bid of 1.26714. The spread is therefore 0.00010
- Pip: This is defined as the unit of measure used to express the smallest change in value between two currencies.
Decimal point range divided by exchange rate
= .0001/exchange rate between the two currencies
Example: If the EUR/USD moves from 1.2240 to 1.2241, the 0.0001 change is one pip.
- Pipette: is one tenth of a pip.
Example: If the EUR/USD moves from 1.22410 to 1.22411, the 0.00001 change is one pipette.
- Leverage: This is defined as the use of credit or borrowed funds to increase one’s speculative capacity and increase the rate of return from a trade.
- Lots: the minimum quantity of a security which may be traded. It is formally defined as the standardized quantity of a financial instrument as set out by an exchange or any regulatory body which may be traded.
Note: This is usually 100 000 currency units.
- Profit and Loss: This refers to the actual realized gain or loss resulting from trading activities on closed positions, plus the theoretical unrealized gain or loss on open positions that have been mark-to-market.
Profit or loss = total profits – total losses
Example: if a trader’s positions were worth $300 yesterday and are worth $380 today, then the Profit for the day was $80. Had the price today been $250; the loss would have amounted to $50.
- Equity: This pertains to the net asset value (“NAV”) in a trading account.
Formula: Equity = Balance + Profit – loss + swap rate
- Types of orders
- Market orders: these are orders to buy or sell at the current best price. They are used when one wants their order to be processed and are willing to take the risk accompanied with it. More simply; an order to buy or sell at the current market price.
- Limit orders: these are orders to buy or sell a contract at a specific or better price. They are used when a trader wants to make sure that they get a suitable price, and are willing to risk not being filled at all. More simply; An order to buy or sell at a pre-specified price level
- Stop orders: they are orders to buy or sell a contract at the best available price, however are only processed if the market reaches a specific price. Stop orders are processed as market order; if the stop price is reached the order will always get filled however not necessarily at the intended price.
Note: there are two common types, namely: Stop entry (an order to buy above the market or sell below the market at a pre-specified level, believing that the price will continue in the same direction) and Stop loss (an order to restrict losses at a pre-specified price level).
- Trailing Stop: This is a type of stop -loss order that adjusts with the price movement to lock in profits.
- Limit Entry Order: An order to buy below the market or sell above the market at a pre-specified level, believing that the price will reverse direction from that point.
- OCO Order: One Cancels Other. An order whereby if one is executed the other is cancelled.
- GTC Order: Good Till Cancelled. An order stays in the market until it is either filled or cancelled.
- Margin: Amount of money required in ones account to maintain their market position using leverage.
- Free Margin: this refers to funds available to open up new positions.
Free margin = Equity – Margin
Note: it is an indicator used to determine the number of transactions which can be opened at any given moment in time.
- Initial Margin: the first batch of funds deposited by a trader as requested by their broker before the trader can be granted the rate to trade on margin.
Feeling smarter now? Well, let’s move on to next chapter to apply some of these terms and remember to refer back to this section should the need arise.