In order to start understanding how forex trading works, we will explain to you the most important terms that you need to know and will be using on a daily basis when trading forex but first let’s see what forex stands for – forex or forex exchange trading is the activity where you can bet if one currency will get stronger or weaker relative to another currency.
Forex market runs electronically within networks of banks, 24 hours, and 5 days a week.
So unlike the stock or bond markets, the forex market does NOT close at the end of each business day
It is the largest market in the world, 5 trillion per day volume vs 22.4 billion per day volume of the New York Stock Exchange (NYSE).
So how we traded forex? Every time when you travel overseas and exchange your money into a foreign currency, you are participating in the foreign exchange, or forex market.
When we will buy or sell? In online trading, when we believe that one currency will rise against another; we buy the strong currency and we sell the weak one. In other word, we can say that we will go long on the EUR/USD pair. So, when we go long on the EUR/USD pair, we actually bet that the Euro will rise against the US dollar. If we believe that the euro will become weaker against the US dollar, we can also sell the Euro against the US dollar and another way we say that we will short the euro/USD pair.
How we make a profit by doing buy or sell? let’s take a real-life example; if we believe that Euro will strong than the US dollar, we will go long on EUR/USD pair. If we open a long position at 1.1150 on Eur/USD pair and its move to 1.1158, we make $8 profit with this trade. How we calculated this profit? very simple. In this case, first, decide which amount we wish to deal with this trade. If we bought 10000 at 1.1150, before the trade begins we have 11,150 US dollar. By entering into a trade, with the same unit, now we have more US dollar ( 10000*1.1158= 11,158). This difference has been called PIPS.
A pip is the smallest amount of change in quoted prices. It is a very small measure of the change in a currency pair in the forex market. The concept of pips is very important in trading in order to understand how exchange rates move, how to calculate the profit or loss on a position, and how to modify an existing position with pips movement. Since most major currency pairs are priced to 4 decimal places, the smallest change is that of the last decimal point which is equivalent to 1/100 of 1%, or one basis point.
- For currency pairs displayed to 4 decimal places, one pip = 0.0001
- Yen-based currency pairs are an exception and are displayed to only two decimal places (0.01)
For example, for EUR/USD, it is 0.0001, and for USD/JPY, it is 0.01.
But there is a big brother of pip in the forex market, it’s called Pipette
What is Pipette?
Some brokers introduce fractional pips, known as a pipette to allow for tighter spreads. That means they quote currency pairs beyond the standard “4 and 2” decimal places to “5 and 3” decimal places.
A fractional pip is equivalent to 1/10 of a pip.