Forex & CFD dictionary: terms explained
In the Forex and CFD dictionary we explain the most important terms in a clear and simple manner to make sure you understand exactly what they mean.
In this list: quotation, bid / ask, lot, pip, pip value, spread, margin, leverage, interest, going long and short, rollover
The quotation is the ratio between two currency pairs. In a quotation the first currency is the base currency and the second currency is the quote currency. The quotation is usually four decimals accurate. The Japanese yen, however, is an exception and is quoted with two decimal figures. A quotation is always displayed as two numbers of which the first indicates the bid or sell price and the second indicates the ask or purchase price.
Bid / Ask
The bid or sell price is the price at which a currency is offered for sale. The ask or purchase price is the price at which the currency can be bought.
With a quotation of EUR / USD – 1.2700 / 1.2702, 1.2700 is the bid price and 1.2702 the ask price. If you want to sell the quoted currency you get 1.27 dollar for one euro and if you want to buy the quoted currency you get one euro for 1.2702 dollars.
A lot is a quantity indication with which you can trade a certain security. Usually one lot is the minimum standard amount you can trade with a broker. With most modern brokers this minimum quantity is 1,000 units, however it can reach up to 100,000 units.
There are micro (1,000 units), mini (10,000 units) and standard lots (100,000 units) in Forex trading.
A pip is the smallest possible difference a currency can change with. Most currency pairs are quoted up to 4 decimals, the value of a pip is then 1 / 10,000 or 0.0001 of the quoted currency. An exception however is the Japanese yen, which has a pip value of 1/100 (0.01) of the quoted currency given that this currency is quoted to two decimal numbers.
Gains on trades are regularly expressed in pips as it makes them easier to compare. The size of the trade is not important, allowing you to compare trades with different lot sizes. If you bought EUR / USD at 1.27 and sold it at 1.28 you’ve made a profit of 100 pips.
It is also possible to calculate the total pip value. Therefore you should divide 1 pip by the exchange rate and multiply it by the lot size. That way you calculate the pip value in terms of the quoted currency. If the base currency of the account is different from the quoted currency you simply multiply the result with the correct answer.
Example: pip value for EUR / USD 1.27 and 10,000 traded units.
• 0.0001 / 1.27 = 0.00007874
• 0,00007874 X 10.000 = 0.79
The spread is the difference between the sell and the purchase price. The spread is the reward for the broker and causes that you always start a position with a very small loss. If for EUR / USD the bid and ask price are respectively 1.2700 / 1.2702, then the difference between them is the spread (0.0002 or 2 pips). CFD brokers usually mention the spread in terms of pips.
The margin is the amount that must be available on the account in order to open a position or to hold a position. The initial margin is the margin that is required to open the position. If the margin is 0.5 percent then for each € 1000,00 traded, € 5,00 must remain available on the account to keep the position open. If the margin is no longer sufficient there could be a margin call, the position is then automatically closed due to lack of funds.
Because most CFD brokers provide the option to trade with leverage you can trade with more money than you actually have on your account. You trade with “borrowed” money, making it possible to increase the potential yield. The leverage is expressed as a ratio, for example 200:1. This implies that the trader can trade with quantities that are 200 times higher than the available funds on the account. If you have € 10,000 on your account, you can trade with a whopping € 2,000,000. If subsequently the price rises or falls with one euro, the profit or loss will be 200 times as high. Total risk is obviously higher as well!
Interest are the costs you pay for borrowing money. Interest is received on loans and paid on deposits. Modern CFD brokers often charge a low financing interest, indeed you lends the largest part of the transaction value from the broker. This interest rate is often about 2-4 percent per year and is listed separately for each instrument. Plus500 displays the interest rate per day already, but if you want to calculate the financing costs per day you should divide the interest rate by 365 and multiply it by the position size.
Going long and short
Anticipating a price increase when buying a currency pair or CFD is called going long. Going long is against the purchase price. Anticipating a price decrease when selling a currency pair or CFD is called going short. Going short is against the sell price, you make money if the price declines.
Every day at about 21:00 GMT, the positions are rolled over to the next day. Positions then lose or receive interest. The amount of interest earned / lost depends on the interest rates in both areas. When interest rates are 3 percent in the euro zone and 4 percent in the United States you will receive interest when you are short on EUR / USD and pay interest when you are long on EUR / USD. For each instrument you can determine whether you have to pay or receive interest and if so how much.