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Forex Codes And Definitions

Each currency is assigned a three-letter code. For example, US dollar is coded - USD (United States Dollar), euro is coded EUR (EURo), Swiss franc is coded CHF (Confederation Helvetica Franc), Japanese yen is coded JPY (JaPanese Yen), British pound is coded GBP (Great British Pound). The rates are represented by 6-letter words composed of two three-letter currency codes. The first position is occupied, as a rule, by the code of a more expensive currency.

The rates are expressed in units of the second currency per unit of the first one. For example, rates USD/CHF (USD-CHF) show the number of Swiss franks in one US dollar, but rates GBP/USD (GBP-USD) show the number of US dollars having to be paid for one British pound. The rates are usually expressed as five-digit numbers. For example, USD/JPY = 121.44 means that 1 US dollar is valued at 121.44 Japanese yens (i.e. they are willing to pay you that many yen for one US dollar while you are buying or selling). At the same time, GBP/USD = 1.6262 means that 1 British pound is valued at 1.6262 US dollars. When the rate has changed, for example USD/JPY = 121.44 to USD/JPY = 121.45 or GBP/USD = 1.6262 to 1.6263, they say that the rate has moved 1 PIP. As it follows from the information above, yen in this example has DEPRECIATED by 1 PIP, but the pound has APPRECIATED, also by 1 PIP.

Standard Forex Definitions

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. Knowing the base currency is important as it determines the values of currencies (notional or real) exchanged when a foreign exchange deal is transacted.

Basis point: One hundredth of a percentage point.

Bid /Ask Spread: The difference between the bid and offer (ask) prices; used to measure market liquidity. Narrower spreads normally signify higher liquidity.

Cable: Trader jargon 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 an account increased in value from $10,000 to $20,000, then dropped to $15,000, then increased again to $25,000, that account would have had a maximum drawdown of $5,000 (incurred when the account declined from $20,000 to $15,000) even though that account was never in a loss position from inception.

Euro: The currency of the European Monetary Union (EMU), which replaced the European Currency Unit (ECU).

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 US, Germany, Japan, France, UK, Canada, and Italy.

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

Hedging: A strategy designed to reduce investment risk using call options, put options, short-selling, or futures contracts. A hedge can help lock in profits. Its purpose is to reduce the volatility of a portfolio by reducing the risk of loss.

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 (also referred to as “lot size” or “contract value”) is $100,000 dollars and the required margin is $10,000, the trader can trade with 10 times leverage ($100,000/$10,000). For investors, leverage means buying on margin to enhance return on value without increasing investment.

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.

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

Market Maker: A dealer that supplies prices, and is prepared to buy and sell at those bid and ask prices.

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.

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: Order executed when a specific price level is reached and/or broken. The execution is handled by the dealing desk and is in effect until cancelled by the trader.

Limit Entry Orders: Orders that are executed when a currency price hits (not touches) a specific level. The trader placing the order believes that after hitting the specific level, the price will move in the opposite direction of its previous momentum.

Limit Orders: A limit entry 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 stop-limit order remains in effect until the position is liquidated or cancelled by the trader.

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

Stop Entry Orders: Orders executed when the currency price breaks through a specific level. The trader placing the order believes that when the currency's price breaks through the specific level, the price will continue in that direction.

Stop-Loss Orders: An entry order linked to a specific position to stop the position form incurring additional losses. A stop-loss order placed on a buy position is a stop entry order to sell that position. A stop-loss order remains in effect until the position is liquidated or cancelled by the trader.