There are different ways to trade forex, but they all work the same way: buying one currency and selling another simultaneously. Traditionally, forex trading was done through a broker, but thanks to online trading providers, you can profit from currency price movements using derivatives such as CFDs.
CFDs are leveraged products that allow you to open a position by paying only a fraction of its total value. Unlike unleveraged products, you do not own the asset, but open a position when you think the market value is going to go up or down.
While leveraged products can magnify your profits, they can also magnify your losses if the market moves against you.
The spread is the difference between the buy price and the sell price of a currency pair. As with other financial markets, when you open a forex position you are offered two prices. If you want to open a long position, you trade the buy price, which is slightly higher than the market price. If you want to open a short position, you trade the ask price, which is slightly below the market price.
Currencies are traded in lots, which are sets of currencies used to standardize forex trading. Because forex moves in small amounts, lots tend to be large: a standard lot is worth 100,000 units of the first currency. Individual investors do not always have 100,000 pounds, dollars or euros to make each trade, so many forex providers offer leveraged products.
Leverage allows you to gain exposure to large amounts of currency without having to commit a large portion of your capital. Instead, you pay a small deposit known as margin. When you close a leveraged position, your profit or loss is calculated based on the total size of your position.
Leverage magnifies your profits, but it also involves the risk of amplified losses, which means that your losses may exceed your margin. Therefore, it is extremely important to learn how to manage your risk when trading with leverage.
Margin is an essential part of leveraged trading. It is the term used to refer to the initial deposit amount you must pay to open and maintain a leveraged position. Please note that when trading on forex margin, your required margin will vary depending on your broker and the size of your trade.
Margin is usually expressed as a percentage of the entire position. Thus, a position on the EUR/GBP pair, for example, may require you to pay only 3.33% of its total value to open it. In this case, instead of depositing €100,000, you would only need to invest €3,300.
Pipes are the units of measure of the movement of a currency pair. A pip usually equals a one-digit move in the fourth decimal of a pair. Therefore, if the GBP/EUR moves from €1.15482 to €1.15492, one pip will have moved. Decimals after the pip are called fractional pips or pipettes.
The exception to this rule is when the second currency is traded in much smaller stocks, the most notable example being the Japanese yen. In this case, a pipo corresponds to a movement in the second decimal. Therefore, if the EUR/JPY moves from 106.452¥ to 106.462¥, one pip will have moved.