Standard Forex Terms

Base currency:   The base currency is the first currency in a currency pair, and the currency that remains constant when determining a currency pair's price. The United States Dollar (USD) and the European Union Euro(EUR) are the dominant base currencies in terms of daily traded volume in the foreign exchange market. The British Pound (GBP), also called sterling or cable, is the third ranking base currency. The USD based pairs are USD/JPY, USD/CHF and USD/CAD; the Euro based pairs are EUR/USD, EUR/JPY, EUR/GBP, and EUR/CHF. The GBP is the base for GBP/USD and GBP/JPY. The Australian Dollar (AUD) is its own base against the USD (AUD/USD).

Basis:   The difference between the spot price and the futures price.

Basis point:   One hundredth of a percentage point.

Bid /Ask Spread:   The difference between the bid and offer (ask) prices; also known as a two-way price.

Cable:   Trader term for the British Pound Sterling referring to the Sterling/US Dollar exchange rate. Term began due to the fact that the rate was originally transmitted via a transatlantic cable starting in the mid 1800's.

Central bank:   The principal monetary authority of a nation, controlled by the national government. It is responsible for issuing currency, setting monetary policy, interest rates, exchange rate policy and the regulation and supervision of the private banking sector. The Federal Reserve is the central bank of the United States. Others include the European Central Bank, Bank of England, and the Bank of Japan.

Conversion:   The process by which an asset or liability denominated in one currency is exchanged for an asset or liability denominated in another currency.

Cross rates:   An exchange rate between two currencies. The cross rate is said to be non-standard in the country where the currency pair is quoted. For example, in the US , a GBP/CHF quote would be considered a cross rate, whereas in the UK or Switzerland it would be one of the primary currency pairs traded.

Currency:   A country's unit of exchange issued by their government or central bank whose value is the basis for trade.

Currency (exchange rate) risk:   The risk of incurring losses resulting from an adverse change in exchange rates.

Devaluation:   Lowering of the value of a country's currency relative to the currencies of other nations. When a nation devalues its currency, the goods it imports become more expensive, while its exports become less expensive abroad and thus more competitive.

Drawdown:   The magnitude of a decline in account value, either in percentage or dollar terms, as measured from peak to subsequent trough. For example, if a trader's account increased in value from $10,000 to $20,000, then dropped to $15,000, then increased again to $25,000, that trader would have had a maximum drawdown of $5000 (incurred when the account declined from $20,000 to $15,000) even though that trader's account was never in a loss position from inception.

End of day (mark to market):   Mark-to-market values a trader's open position at the end of each working day using the closing market rates or revaluation rates. Generally the revaluation rates are market rates at 5pm EST time. Any profit or loss is booked and the trader will start the next day with the position valued at the prior day's closing rate.

Euro:   The currency of the European Monetary Union (EMU), which replaced the European Currency Unit (ECU). The countries currently participating in the EMU are Germany, France, Belgium, Luxembourg, Austria, Finland, Ireland, the Netherlands, Greece, Italy, and Spain.

Exchange rate:   The price of one currency stated in terms of another currency. Example: $1 Canadian Dollar (CDN) = $0.7700 US Dollar (USD)

Fixed exchange rate:   A country's decision to tie the value of its currency to another country's currency, gold (or another commodity) , or a basket of currencies . In practice, even fixed exchange rates fluctuate between definite upper and lower bands, leading to intervention.

Foreign exchange (Forex):   The simultaneous buying of one currency and selling of another in an over-the-counter market.

G-7:   The seven leading industrial countries, being the United States, Germany, Japan, France, Britain, Canada, and Italy.

G-10:   G7 plus Belgium , Netherlands and Sweden , a group associated with the IMF discussions. Switzerland is sometimes involved.

G-20:   A group composed of the Finance Ministers and central bankers of the following 20 countries: Argentina , Australia , Brazil , Canada , China , France , Germany , India , Indonesia , Italy , Japan , Mexico , Russia , Saudi Arabia , South Africa , South Korea , Turkey , the United Kingdom , the United States and the European Union. The IMF and the World Bank also participate. The G-20 was set up to respond to the financial turmoil of 1997-99 through the development of policies that “promote international financial stability”.

Hedge fund:   A private, unregulated investment fund for wealthy investors (minimum investments typically begin at US$1 million) specializing in high risk, short-term speculation on bonds, currencies, stock options and derivatives.

Hedging:    A strategy designed to reduce investment risk. Its purpose is to reduce the volatility of a portfolio by investing in alternative instruments that offset the risk in the primary portfolio.

London Inter-Bank Offer Rate or LIBOR:   The standard for the interest rate that banks charge each other for loans (usually in Eurodollars ). This rate is applicable to the short-term international interbank deposit market, and applies to very large loans borrowed from one day to five years. This market allows banks with liquidity requirements to borrow quickly from other banks with surpluses, enabling banks to avoid holding excessively large amounts of their asset base as liquid assets. The LIBOR is officially fixed once a day by a small group of large London banks, but the rate changes throughout the day.

Leverage:   The degree to which an investor or business is utilizing borrowed money. The amount, expressed as a multiple, by which the notional amount traded exceeds the margin required to trade. For example, if the notional amount traded is $100,000 dollars and the required margin is $2000, the trader can trade with 50 times leverage ($100,000/$2000). For investors, leverage means buying on margin to enhance return on value without increasing investment. Leveraged investing can be extremely risky because you can lose not only your money, but the money you borrowed as well.

Liquidity: The ability of a market to accept large transactions. A function of volume and activity in a market. It is the efficiency and cost effectiveness with which positions can be traded and orders executed. A more liquid market will provide more frequent price quotes at a smaller bid/ask spread.

Long:   A position purchasing a particular currency against another currency, anticipating that the value of the purchased currency will appreciate against the second currency.

Margin:   Funds that customers must deposit as collateral to cover any potential losses from adverse movements in prices.

Margin Call:   A requirement for additional funds or other collateral, from a broker or dealer, to increase margin to a necessary level to guarantee performance on a position that has moved against the customer.

Market Maker:   A dealer that supplies prices, and is prepared to buy and sell at those bid and ask prices. All CFTC registered FCMs are market makers.

Pip (tick):   The term used in currency markets to represent the smallest incremental move an exchange rate can make. Depending on context, normally one basis point (0.0001 in the case of EUR/USD, GBD/USD, USD/CHF and .01 in the case of USD/JPY).

Position: A view expressed by a trader through the buying or selling of currencies, and can also refer to the amount of currency either owned or owed by an investor.

Premium (cost of carry):   The cost or benefit associated with carrying an open position from one day to the next calculated by using the differential in short-term interest rates between the two currencies in the currency pair.

Revaluation:   An increase in the foreign exchange value of a currency that is pegged to other currencies or gold.

Revaluation rates:   The rate for any period or currency, which is used to revalue a position or book. The revaluation rates are the market rates used when a trader runs an end-of-day to establish profit and loss for the day.

Rollover: The settlement of a deal is rolled forward to another value date with the cost of this process based on the interest rate differential of the two currencies. An overnight swap, specifically the next business day against the following business day.

Short:   To sell a currency without actually owning it, and to hold a short position with expectations that the price will decrease so that it can be bought back at a later time at a profit.

Spread: The difference between the bid and offer (ask) prices of a currency; used to measure market liquidity. Narrower spreads usually signify high liquidity.

Spot Price:   Current market price. Settlement of spot transactions normally occurs within two business days.

Swaps:   A foreign exchange swap is a trade that combines both a spot and a forward transaction into one deal, or two forward trades with different maturity dates.

Uptick:   A new price quote that is higher than the preceding quote for the same currency.

 

Types of Foreign Exchange Orders

Entry Orders:   An order, stop or limit, initiating an open position and executed when a specific price level is reached and/or broken. The execution is handled by the dealing desk and the order is in effect until cancelled by the client.

Entry Limit Orders:   An order initiating an open position to sell as the market rises, or buy as the market falls. The client believes the market will reverse direction at the level of the order.

Entry Stop Orders:   An order initiating an open position to sell as the market falls, or buy as the market rises. The client placing the order believes that prices will continue to move in the same direction as the previous momentum after hitting the order level.

Limit Orders:   A limit order is an order tied to a specific position for the purpose of locking in the gains from that position. A limit entry order placed on a buy position is an order to sell. A limit order placed on a sell position is an order to buy. A limit order remains in effect until the position is liquidated or cancelled by the client.

Market Order:   An order to buy or sell which is to be filled immediately at the prevailing currency price.

OCO (One Cancels the Other):   A stop-loss order and a limit order linked to a specific position. One order, the stop, is to prevent additional loss on the position, and one order, the limit is to take profit on the position. When either order is executed, closing the position, the other is automatically cancelled.

Stop-Loss Orders:   An order linked to a specific position to close that position and prevent additional losses. A stop-loss order placed on a buy position is an order to sell that position. A stop-loss order on a sell position is an order to buy that position. A stop-loss order remains in effect until the position is liquidated or cancelled by the client.