As in any industry, trading has its own jargon. In order for you to have a better understanding of market reviews that you can read on our website, or in any economical newspaper, it is important that you speak the same language. This section therefore aims to make sure that you have all the pre requirements and fundamentals to understand the Forex market.
The "PIP" is the basic unit used for all calculations in Forex. In a quotation, it is represented by the last digit after the decimal point.
Everything will be expressed in terms of pips; Your earnings, volatility, data forecast…If the rate of the Euro against the Dollar increases from 1.4255 to 1.4258, we say that the EUR/USD has gained 3 pips.
The spread is the difference between the buy or bid price and the sell or ask price. If you look at the rate of the EUR/USD on your trading platform, you will find that there are always two prices.
The difference between the two prices is the spread and is calculated in terms of pips. The vast majority of brokers have a 3 pip spread on EUR / USD, as illustrated in the table above.
The notion of spread is very important because it represents the remuneration of the broker. To understand how your broker is compensated, it can be compared to an exchange bureau. If you have Euros and you want Dollars, you will not have the same price than if you had Dollars and wanted to buy Euros. It is precisely on this difference that your exchange bureau is making profit.
For the broker it is the same concept! Every time you open a position on their platform, the broker acquires the value of the spread.
The concept of leverage is still the source of much misunderstanding for beginner traders and yet, it is very important to master this notion in order to be successful. Therefore, we will try to explain the leverage by keeping it as simple as possible.
LEVERAGE = MULTIPLIER EFFECT
If we take a step back and have a look at the absolute daily volatility of the prices on the Forex market, they are extremely low. A very volatile day will see the rates move on a 100 to 150 pip range.
What are the expected gains for such moves?
If we consider a 150 pip gain with an investment of 100 Euro on the EUR/USD
Value of a pip
100 x 150 x 0.0001 = 1,5 $
A day with 150 pip gain is quite rare and would involve irreprehensible trading. Yet, it would have only generated a $ 1.5 profit. Everybody would agree on the fact that it is a pretty terrible paycheck for such a great trading day. Let's see what the outcome would be with larger investments...
If we consider a 150 pip gain with an investment of 1.000 Euro on the EUR/USD
Value of a pip
1.000 x 150 x 0.0001 = 15 $
If we consider a 150 pip gain with an investment of 10.000 Euro on the EUR/USD
Value of a pip
10.000 x 150 x 0.0001 = 150 $
If we consider a 150 pip gain with an investment of 100.000 Euro on the EUR/USD
Value of a pip
100.000 x 150 x 0.0001 = 1.500 $
According to the above calculations, it is evident that trading currencies can only be worth its while with a minimum capital of 10.000 €. It is for this precise reason that this type of trading was the privilege of institutional investors only a few years ago. By offering a leverage that can go up to 400:1, online brokers have opened the doors of Forex to the masses.
The idea is to multiply your initial capital by the coefficient of the leverage. If you open a mini account with € 100 and the broker provides you with a 200:1 leverage, your investment potential is
100 Euros x 200 Leverage = 20.000 Euros
That same 150 pip gain day discussed earlier, would have returned:
20.000 x 150 x 0.0001 = 300$
YOU WOULD THEN HAVE TRIPLED YOUR INITIAL INVESTMENT !
Leverage is certainly one of the key reasons why Forex is such an attractive market. It allows you to make large sums of money with quite a small initial investment. However, it is important to bear in mind that if leverage can multiply your earnings, it can also multiply your losses. Therefore leverage should be used with caution and we recommend that you refer to the risk management section on our website.
One of the most recurrent questions is: "Can I lose more than what I initially invested?” The answer is of course NO! The broker will not allow you to lose more than your capital and will automatically close your positions once you reach to zero balance. This is what we call a “Margin Call”. You will never find yourself in a situation where you owe money to the broker.
With the leverage, the sums of money involved can quickly become quite large. To avoid getting lost in the zeros, certain platforms, including the well-known Metatrader 4, operate with a lotification system.
100.000€ = 1 lot
10.000€ = 1 mini-lot
1.000€ = 1 micro-lot