The skill of forex trading may be easier to grasp for persons who are already knowledgeable or actively involved in the trading of stocks. Nevertheless, there are many aspects of trading that are unique to forex trading that the beginner would do well to take into consideration. It is important to understand forex trading jargon in order to hit the ground running when starting out in forex trading.
Here are some terms that you will encounter often and that you should therefore know:
Pip – A pip is the unit of change of any given exchange rate. It is the smallest measurement of a change in the rate of exchange between any two currencies. In currency exchange rates that are quoted to 4 decimal places, the last decimal place represents a pip. In exchange rates that are quoted only to 2 decimal places, such as the Japanese Yen (JPY), a pip is the second decimal place.
Currency Pair: A currency pair is simply the pair of currencies that are being exchanged on the forex market. Eg. USDGBP is a currency pair which consists of the US dollar and the Great British Pound.
Base Currency: The base currency of a currency pair is the domestic or accounting currency. This currency is usually quoted first in a currency pair. So, in the USDGBP currency pair, the base currency would be the US dollar.
Quote Currency: This is usually the foreign currency of a currency pair and is normally the second currency of a currency pair. In the USDGBP currency pair, the GBP is the quote currency.
Cross Currency Pair: Any currency pair that does not include the USD, is regarded as a cross currency pair. Eg. EURGBP is a cross currency pair since it does not include the US dollar.
Purpose of Forex Trading
In a global economy where trade takes place among different nations, it is necessary to find a way to value one currency against another. This is where forex trading becomes necessary. A tourist from England who is travelling to the US, would need to trade his domestic currency to purchase US dollars because US dollars are the acceptable currency in the United States. Similarly, someone travelling from the US to another foreign country, would need to sell their US dollars in exchange for the currency of that particular location.
Apart from the purpose of facilitating business transactions, forex trading may be undertaken for the purpose of making gains as a result of differences in exchange rates. For example, a forex trader may purchase a currency at one exchange rate and then later sell that currency when the exchange rate increases in order to realize a profit. Forex trading is also useful for hedging against foreign currency exchange risk.
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