As you know having knowledge is the key to success in the forex market. Because of that I decided to write an article about some very important terminology used in forex market - margin, leverage, bid, ask, spread and electronic communication network(ECN). Even if the global network is full of such information, I believe that my point of view will help at least some of you to understand these topics. I hope you will like it and share it.
I plan to have a look at these points:
- Bid price
- Ask price
- Bid-ask spread
- Regulation of the price values
- Electronic Communication Network
In order to trade in forex market every trader has to open an account in a brokerage. This means they have to top-up their account with a certain amount of money and this amount is called margin. This can be completely different in the brokers. This value is around $5 and $100 000(they can be in much wider interval).
Every time when a new order is opened, an amount of your margin will be used as required based on your currency pair, price and lots size and the lot size is defined in your base currency. Main lot size is 100 000 units. However, some brokers allow you to trade in accounts called micro, nano, cent etc., with mini lots amount of 10 000 units, micro lots is 1 000 units, and standard lots is 100 000 units. It is good to mention there is bank lot which is 250 000 units.
The USA trader's minimal margin is defined by NFA and it is 2%, or 50:1 leverage, for the base currency pairs and 10%, or 10:1 leverage,for the exotic pairs.
The total amount of your all open positions cannot exceed 50:1 in base pairs. This can be a drawback for the traders who trade often and for short periods, and looking for small profits, making many trades. Having 50:1 is acceptable value, however, for the exotic pairs this rate 10:1 is a little bit not pleasant. So, when you try to open a trade when your margin is not enough your position will be rejected by the metatrader 4 or 5 trading platform.
2) Leverage in forex market
Leverage is the ratio of the used amount of your trade to the required deposit, shortly margin. This is a technique which allows the traders to manage big amount of balance but with a small deposite made by the trader. Every broker has its own policy and terms and conditions, therefore the leverage value can be different in every broker. This amount can vary between 1:10 to 1:1000, even can be meet other values.The most used leverage ratio is between 1:100 and 1:500. Here is the forumal how to calculate your leverage:
leverage = 100 / margin in per cent
The recommended leverage for the newbies is 20:1 and it should not be higher than 50:1. Leverage 50:1 could hinder for short term and big players in the market. Forex Traders define their leverage since they define their lots size as well. However, your broker is obligated to specify the maximum value for this purpose by the law.
3) Bid price
Bid price is the one which the market is ready to buy currency pair. For this price the trader could sell base currency. It is marked on the left side of the currency pair. For ex. EUR/USD 1.12521/23 the bid price is 1.12521 and this means that you can sell 1 EUR for 1.12521 USD. The trader sell for bid price.
4) Ask price
Ask price is the one which the market is ready to sell currency pair. For this price the trader could buy base currency.It is marked on the right side of the currency pair. For ex. EUR/USD 1.12521/23, the ask price is 1.12523 and this means that you can buy 1 EUR for 1.12523 USD. This price is aslo called "quotation". The trader buy for ask price.
5) Bid-ask spread
Spread is the difference between bid and ask price. The big figure a term mostly used for the first numbers of the exchanged currency pairs. In most cases, these are the numbers omitted when the traders provide quotations in fast-paced markets. For ex. the price of GBPUSD 1.25030/1.25035, in the terms of conversation would be truncated to "30 and 35". It is good to mention again that the traders sell on bid price and buy on ask price. In most cases, these values are mentioned as pips in the prices and this also could be called 4 and 5 digits calculations.
6) Regulation of the price values
It is good to mention that the prices in the forex market are defined by this formula
base pair/quote pair bid/ask
And here are other examples:
- EUR/USD 1.12505/07
- GBP/USD 1.25030/1.25035
- USD/JPY 108.465/70
7) Electronic Communication Network
ECN(Electronic communication Network) is financial institution who takes trades. These brokers often mediate between contractor of liquidity and clients(traders). In some cases, ECN could play the role of market makers. It is recommended to read the specifications of the brokers and look for instant execution of the requests and if this is the case it is good for you. Mostly, the big institutions such as banks, they will not serve lots smaller than 250 000 units in order to take ask/bid price.For this reason, most traders with experience prefer ECN, however, this has its own drawbacks.
I tried to share some information about leverage, bid, ask, bid-ask spread, regulation and ECN. I hope it will be useful for you. As a conclusion, I want to mark that it is very important for any newbies to understand the concept of the forex trading before start trading with REAL money accounts. For that reason, I recommend you to read my article or find other articles related to these terminology, which is very important part of the trading. If you like it please share and help to grow our community.
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