Every industry has its own terminology and culture. Forex is no different and it too has its own unique Forex terminology. Understanding the terms and using them correctly can go a long way towards a profitable Forex trading experience.
Long or Short
A long position is a situation in which one purchases a currency pair at a certain price in anticipation of selling it down the road at a higher price. This concept is referred to as the “buy low, sell high” method of trading. A short position is the opposite of a long position. In Forex, a short position occurs when one currency in a pair rises in value while the other currency in the pair declines or vice versa. A trader will ‘short’ his position if he thinks a currency pair will fall; he will sell it and hope to buy it back later at a lower price.
In every Forex trade, a trader maintains a long position on one currency of the pair and a short position on the other currency. A trader’s position is defined as an expression of the first currency of the traded pair which is known as the base currency. The second currency in the pair is called the counter currency. When a trader buys the base currency he is taking a long position on a pair; if he sells the base currency he is shorting the pair.
What is a Pip?
One of the most important terms in Forex terminology is the ‘pip.’ A pip in Forex trading is a change in price of one “point” and it is equivalent to the final number in a currency pair’s price. This differs for certain currency pairs. For example, if one of the currencies in the pair involves the Yen, a pip is counted from the second decimal place, 120.94. For those pairs that don’t involve the Japanese Yen, a pip is the fourth decimal place, 1.3279.
Forex brokers use specific Forex terminology when marketing their products. A bid price is the rate at which the market is prepared to buy a specific currency pair in the Forex trading market. This is the price that a trader will receive when shorting (selling) a currency pair. An ask price is the rate at which the market is ready to sell a particular currency pair. This is the price that a trader will have to pay in order to long (buy) the currency pair. The bid/ask combination constitutes a quotation, which is based on a floating exchange rate. The quotation lists the bid price first, then the ask price. For the USD/JPY pair the quote will be 120.93/96.
The difference between the bid and ask is known as the spread, which indicates the disparity between the rate offered by a market maker to sell a currency pair and the rate at which the market maker will buy the pair. The value of the spread is lower for the major trading currencies and is greater for currencies that are traded less frequently on the market. Spreads can be fixed or variable. Forex market makers generally do not charge a commission for every transaction, and instead obtain their compensation from the spread. There are, however, some Forex brokers that do charge a commission for every trade. Commissions can also be fixed or variable.