Let’s introduce some basic forex terms using an example.

If an American tourist plans to visit France, he will sell dollars and buy euro. This transaction will be made at a certain exchange rate, and the currency pair to be traded is EUR/USD. If the tourist wishes to exchange 1,000 dollars at the rate of 1.1500 dollars per euro, he will leave with approximately 870 euros (1,000/1.1500 = 869,57). Let’s assume that the trip is cancelled and the euros need to be exchanged back for dollars. The exchange rate has already changed to 1.2000. In this scenario, the tourist would receive 870*1.20 = 1044 dollars (a profit of $44).

Base and quote currencies: the first currency in a pair is called the base currency because it indicates what the value is per unit of it measured in another (quote) currency. Thus, in the example above, we see that one euro was originally equal to $1.15. Subsequently, one euro is worth $1.20. We see that the second currency in the pair is the variable that determines whether the base currency appreciates or depreciates. For this reason, it is called the quote currency. In the above example, the base currency, the euro, has appreciated and the quote currency, the dollar, has depreciated relative to the euro.

Long positionShort position: these two terms are synonymous for buying and selling particular currency pair. We are “long” when we have bought a certain amount of the base currency and we are “short” when we have sold the base currency. Thus, when we open a long position in EUR/USD, we will profit from the appreciation of the euro.

Bid price / Ask price: for each currency pair, the broker provides two different quotes – on one he buys (bid price) and on the other he sells (ask price). It is important to remember that buy/sell actions are implemented from the broker’s perspective and refer to a unit of the base currency – in this case, the euro.

In the above example, the American tourist made purchases of euros at 1.1500, i.e., the broker sold at the “ask price” (or offer price) in exchange for $1.15 for each euro. Subsequently, the reverse transaction was implemented – the broker bought euros from the tourist, i.e., the broker’s “bid price” was $1.2000 per euro.

Spread: the difference between bid and ask price is called the spread. The buy rate is always lower than the sell rate, which eliminates the possibility of making a risk-free profit by simultaneously buying and selling a pair.

Let’s go back to the example above, assuming that the “bid price” for EUR/USD is 1.1490, and the “ask price” is 1.1500. The broker sells the euro at 1.1500, and the tourist buys accordingly at these levels. Thus, for his 1000 dollars, he gets 869.57 euros. If at the same time he decides to sell his euros back for dollars, the transaction will take place at 1.1490. Thus, he would receive 999.14 (869,57 x 1.1490) dollars. A minimal loss is realized as a result of the simultaneous execution of the two opposite transactions.

The spread is a major source of income for brokers. Depending on the currency pair, it can be narrower or wider. Logically, the more liquid a currency pair is, the smaller the spread.

Pip: The pip is the unit of measurement for the smallest change in the value of a currency pair and is reflected in the fourth decimal place (0.0001). If the EUR/USD exchange rate changes from 1.1500 to 1.1501, the change will be equal to one pip. Exceptions are currency pairs including the Japanese yen, where the pip is reflected in the second decimal place. The change in USD/JPY from 120.00 to 120.01 is equal to one pip.

Given the growing competition between different brokers and narrowing spreads, we often see quotes with five decimal places. The fifth digit is called a pipette. For example, a change in the EUR/USD exchange rate from 1.15005 to 1.15015 represents a change of ten pipettes or one pip.

For larger price changes, traders use the term “figure”. One figure is equivalent to 100 pips (from 1.1500 to 1.1600).

Lot: Most brokers offer standardized trading volumes. The lot represents the number of units of the base currency to be traded. The standard lot is equal to 100,000 units, the mini-lot is 10,000 units, the micro-lot is 1,000 units, and the nano-lot is 100 units.

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