Fundamental Definitions in Financial Market
Fourth session of Forex Training
Welcome back to Forex professional training in financial markets.
In this session we will explain the basic and fundamental definitions in financial market that you will face. We will start with symbols.
A currency symbol consists of three letters, where the first two letters stand for the name of a country, and the third letter for that country’s currency.
Here are the top 8 most globally recognized currencies and their symbols.
- USD – United States Dollar
- CAD – Canadian Dollar
- JPY – Japanese Yen
- NZD – New Zealand Dollar
- GBP – British Pound
- AUD – Australian Dollar
- EUR – European Euro
- CHF – Swiss Franc
In a financial market, when we talk about symbols, we are usually trying to find out the value of one currency against another.
There is always a ratio between currencies in financial markets. Currencies based on a dollar (of any kind) are called Major currencies.
These are written in two different ways: in a form of the denominator, for example the Euro and the US Dollar – EURUSD; second way is an indirect, for example the US Dollar and the Japanese Yen - USDJPY.
All other currencies, like EURGBP, are referred to as cross, and are usually read as X divided by Y, where X represents the main currency, while Y specifies the opposing currency.
Precious metals are a bit different, spot gold is referred to as XAU or XAUUSD (against the US Dollar) and future gold is termed GCXX. However, future gold may also be shown as XAU, but it will be in its own future gold section on the Meta trader.
When dealing with energies, the most common of all is oil, which is shown as CLXX, where the XX will change from contract to contract. This will always be found in the future section on the Meta trader.
If we look at the Metatrader platform, we will see many different types of symbols. Again, for example, USDCHF is the US Dollar against the Swiss Franc. You will also see a spot gold and oil symbols, such as XAU and CLXX, which are always calculated as future instruments.
Now it is time to talk about PIP. This is the smallest measurement of change in a currency pair. For instance, if the price of EURUSD is 1.3800 and it rises to 1.3801 or falls to 1.3799, it changed by one PIP.
If you divide one PIP by ten, you will have 10 Pipettes, which will add one extra decimal digit to the currency pair value.
For instance, if the EURUSD is shown as 1.38500 and it rises to 1.38501 or falls to 1.38499, it has gained or lost 1 Pipette, respectively.
A 5 decimal places figure is more accurate than a 4 decimal places figure, as it allows you to observe any small changes in the price, therefore giving you greater insight and a higher chance of making a profit.
When writing a currency as a symbol you must do it to a 4 decimal places figure representing the PIP value, or a 5 decimal places figure representing the Pipette Value.
All others symbols with JPY or against oil and silver are represented in either a 2 decimal place format for PIP and in a 3 decimal place format for pipette, or against gold 1 decimal format represents the value in PIP and 2 decimal format in pipette.
If you actually look this up on the platform, you will see here GBPUSD is shown in five decimal format and USDJPY is in pipette values since it has three decimal digits.
It is also clear to see gold prices, which are measured in pipette with two decimal places, and again oil is also represented with two decimal places but in PIP format.
The Next subject is called the Spread, which means the difference between a buying and asking price, as well as selling and bidding price. For instance, if the price of EURUSD is 1.3820 and it changes to 1.3822, the two-pip increment is the spread.
In order to describe the size of transactions we use a term “Lot”. One Lot is equal to 100,000 units. It means if you are trading one lot using major currencies, you will lose or gain 10 dollars, and when you deal one tenth of a lot, you are dealing 10,000 units or 1 dollar.
If you are dealing with one hundredth of a lot, which is equal to 1,000 units, you will lose or gain one tenth of a dollar. Usually the lowest amount traded in standard accounts is 0.1, while in Mini accounts it is 0.01 and in Nano accounts it is 0.001.
However, there are very limited numbers of brokers who offer a trade for such a low amount.
There is a formula to calculate your gains and losses which is:
The values difference, multiplied by the size of transaction, multiplied by net profit for trading value. Or, (values of difference) x (size of transaction) x (net profit for trading). For a better understanding let’s look at these examples in which our base unit will be 50.
Example 1 We are trading 1 lot, our value difference is 50 and our size of transaction is one unit. Therefore, for every one lot we will gain or lose 10 dollars.
If inserting the numbers into the formula it looks like this: 50 x 1 x 10 = 500.
Example 2 We are trading 0.2 lot, our value difference is still 50.
After applying the formula it looks like this: 50 x 0.2 x 10 = 100.
Example 3 We are trading 0.03 lot, our value difference remains at 50. Apply the formula once more: 50 x 0.03 x 10 = 15
Dollar was the base currency in all of the above examples.
It is different for all other indirect currencies, for instance if USDJPY exchange rate is 102.57, this means that each 100 Yen is worth 102 dollars. So we must divide 2 by 102 to get 0.02, which we will add to it.
We must then divide 10 by 1.0257 (a hundredth of the exchange rate) to give us 9.749 which is the amount of profit or loss we will make on exchanging these currencies.
The next thing which will accompany small parties to participate in this market is Leverage. This will also pose a risk for the party, because they can loan several times more than their capital from their broker at the moment of trade.
The quantity of this loan between brokers is variable. For instance. Some brokers may even go up to 1000-2000 in leverage, but you should know that the standard amount is between 100 and 500.
You should also consider that the higher the leverage, the higher risk it holds.
The next step is a Margin. A margin is a collateral that the holder of a financial instrument has to deposit to cover some or all of the credit risk of their counterparty (most often their broker or an exchange).
As you can see, our investment is 50,000 dollars and this is a demo account. The margin which was asked for the positions here is 252.98 dollars and at the moment we are losing 33.90 dollars.
Now if we add our profit or loss to the amount of margin, we will have a free margin. Thus, anytime that we close the position, a free margin amount will be charged to the account.
Remember that the bigger size of a transaction, the bigger margin it makes. When a party miscalculates their account and the account goes down almost to zero, it’s referred to as margin call.
Next is a Swap, which is related to the interest rates. This interest rate is always calculated exactly at midnight.
As you can see the FXPRO server time is 18:25 now, and at midnight the swaps will be added to the account. As you can see, at the moment we have some positions.
The positive swap, which is the difference between the interest rates and the brokers cut, is usually added to the open positions when it is positive.
The negative swap, which is the difference between the interest rates plus the brokers cut, is subtracted each night because of your open positions.
You should know the both of these numbers are negative. Wednesdays- are the busiest days for swap. This is because Wednesday, Saturday and Sunday are holiday days.
This means all the swaps from these days are processed on Wednesday night and early Thursday morning.
That concludes this session, until next time and another session take care.