Forex Glossary

Pip

A PIP measures the amount of change in the exchange rate for a currency pair at the fourth decimal, if it has only one digit before the comma. Therefore a PIP usually signifies a change of the exchange rate of 0,0001. The majority of the Forex brokers even offer exchange rates with five decimal places; these smallest changes are called points. The exchange rate of the Japanese Yen and the US dollar has three digits before the decimal point. Here a PIP corresponds to a change of 0,01.

 

Lot

Forex trading is done with specific contracts called Lot. A standard Lot are 100.000 units of the base currency. A Mini-Lot (0.1 Lot) is equivalent to 10.000 units. The smallest tradable size is 0.01 Lot and is referred to as Micro-Lot.

1 Lot EUR/USD long is defined by buying 100.000 units of Euros. With an exchange rate of 1,1024 you would sell 110240 units of Dollars at the same time. If the price changes in its favor by 10 pips to 1,1034, the euro-position achieves a profit of $100 from the USD-point-of-view. Vice versa, this implies that if you are 1 Lot EUR/USD short, you would sell 100.000 units of EUR and bet on a rising USD.

 

Spread

The spread is the difference between the ask-price and the bid-price and can be considered as the broker's charge. To get low spreads, many brokers offer accounts with a fixed commission. In return, you get spreads of only a few points, whereas accounts without commission usually have a spread of one or two PIP's in the major currency pairs. Thus: The higher the spread, the more a currency rate must pass in the desired direction before it comes into the profit zone.

 

Leverage

Forex trading is usually carried out with leverage and thus with additional capital, which the broker provides. This is a typical indicator of Forex trading, since you need significantly less seed capital than for example in stock trading.

 

Margin

When you decide to have a position with leverage, you can look at the margin as a guarantee which the broker calls for. The volume of margin to enter a position depends on leverage and lot size.

For example, trading 0.1 Lot EUR/USD with a leverage of 1:100, i.e. €10.000, the broker will ask for €100 to serve as collateral.

 

Margin Call und Stop Out

Based on the previous example, if you invested €100 and now trade a €10.000 EUR/USD-position, it will depend on whether you have further capital available to deal with unfavorable price movements. Assuming that there are another €100 available and the position develops 50 Pip’s to your disfavor, an equity of only €50 will be left to cope with. Now mechanisms are initiated to prevent that the account slips into the red. A warning, the so-called margin call, is triggered, to either close the position or to deposit new money. If you do not react or if the position develops too quickly in your disfavor, at a certain level it will come to a stop out. Thereby the broker automatically closes losing positions, starting with the position that indicates the largest loss.

 

Rollover-Swap

A swap- or rollover fee is being charged, if a position is held open overnight. In Forex trading, swap means the difference between the interest rate of the two currencies of a currency pair traded with. The swap is being calculated, based on the position - long or short. Depending on the currency pair, the trader either gets a loss of interest or a profit.

 

Slippage

Slippage is defined by the execution of an order at a different price than expected. Based on the fact that in fast-moving markets, such as Stock trading or Forex trading, price changes occur frequently on very short notice, slippage is not an unusual phenomenon. The risk of slippage is particularly high with decreasing market liquidity. This may be observed in the direct temporal environment of important economic data releases. Another reason for slippage can be the self-serving intervention of the broker, by executing customer orders at less favorable prices. In general, slippage can also benefit traders. This happens when a simple market order is executed to a better than the displayed price. Usually you will observe negative slippage, however the negative effect should not be too great, especially, since from a technical point of view, trading entirely without slippage but with simultaneous direct market access, is not possible.

 

Stop-Level

The stop-level describes the distance, measured in PIP's, in which, relative to the initial course, a stop-loss can be set at the earliest. Usually it depends on the broker model if there is a stop level or whether a stop-loss can be set close to the entry price. This is vitally important while scalping with the breakout strategy, as very tight stop losses are used.

 

Demo account

Almost all Forex brokers offer a free demo account to get started in Forex trading. This gives you the possibility to learn the complex rules and trading strategies with a simulation that is based on real market conditions. Only virtual money is being used while trading with a demo account.

 

Back test

The MetaTrader software includes a function to test the operation of an Expert Advisor. The Strategy Tester allows to simulate the trading-behavior of EAs for any arbitrary period of time and to analyze the impact of changes to different trading parameters. For this purpose, appropriate historical price data must be available. To get realistic back tests it is necessary that the quality of the historical price data is accurate. Additionally, it should be considered that since back testing is only done with historic bid-prices, you will not be able to consider the effects of the actual spread retrospectively. Consequently, live test are more accurate than back test. Based on back testing it is only possible to get a trend statement of the Expert Advisor's expected performance. Therefore, it is always helpful to test an Expert Advisor on a demo account, which reflects almost real trading conditions. Thus its expected performance can be verified.