Beginner Level

Learn basic topics about forex, platforms and trading.
If you are new to the markets, start here.

Lesson 5: Basic Trading Terms and Concepts

Market trading can seem incredibly overwhelming and confusing when you get started first. With a large amount of information easily accessible online, as well as ever-increasing ways to interpret charts, data and fast-moving markets, it’s easy to be overwhelmed or succumbed to the fear of the unknown. One of the best things to keep in mind is elegance. Let’s continue step by step with simple terms and concepts that will be used on your trading journey.

Leverage

Leverage helps you to achieve a large
market exposure for a relatively small initial deposit. Whenever you see a
percentage like 5% or 10:1 when you refer to the initial deposit, that is the
amount of leverage available on this market.

Let’s illustrate this by comparing it with
traditional investments. For example, if you wanted to purchase 10,000 shares
in Barclays and its share price is 280p, the total investment costs £
28,000-not counting commission or other charges that your broker will pay for
the sale.

For CFD trading, however, you only need a
small percentage of the total trade value to open up your position and retain
the same level of exposure. Please remember that when trading CFDs, you don’t
really own the underlying asset. Suppose that XTB gives you 5:1 (or 20 per
cent) leverage on Barclays shares, so you’d only need to deposit an initial £
5,600 to trade the same amount.

When Barclays shares were raised by 10% to
308p, the price of the role is now £ 30,800. Therefore, with an initial deposit
of only £ 5,600, this trade in CFD made a profit of £ 2,800. That’s a 50%
return on your investment, compared to a 10% return on the physical purchase of
the shares.

If the share of Barclays drops by 10% to
252p, the price of the place is now £ 25,200. Therefore, with an initial
deposit of only £ 5,600, this exchange in the CFD amounted to a loss of £
2,800. That’s a-50 per cent gain on your savings, compared to a-10 per cent
loss on the direct purchase of the shares.

Leverage
Benefits:

  • Leverage
    will make it possible for you to get the most out of your investment funds by
    being able to trade huge positions and spend only a fraction of the trade value
    as an initial deposit
  • You
    can also take a much greater position than you would otherwise be willing to do
    with actual investments
  • Your
    returns as a percentage of your initial investment can be much higher.
  • Maximize
    capital investment by trading in a range of different assets.

The
Risks of Leverage:

  • If
    the market goes against your bets, you could lose all your account funds so
    it’s important to understand how to handle your level of risk when trading
  • Just
    as profits can be magnified, so can your losses.

In the retail world of FX & CFD
trading, leverage is key.

Pips

A pip stands for ‘percentage of points.’

A pip is the smallest price change a
business can produce. The length of the tube varies across most industries.

For example, you will notice that most
currencies are priced at four decimal places-meaning that GBPUSD moving from 1.2545
to 1.2546 is a one-pip move. However, one pip in the USDJPY pair is equivalent
to a move in price of 0.01, as that particular pair is only priced at two
decimal places.

You can decide how much you gain or lose
per pip by using a lot size to set the amount of your trade. For example, the
EURUSD 1 lot transaction gives a pip value of £ 7.62.

What this means is that if the market moves
10 pips to your favor, you will generate a profit of £ 76.20 (7.62x 10).
Similarly, if the market moves 10 pips against you, you would have a loss of £
76.20 (7.62x 10). It is very important to know the pip price before opening a
deal on the market in order to fully understand the scale of your possible
profit or loss.

Bid
and Ask

When trading in financial markets, you are
provided with two prices: the asking (buy) price and the bid (sell) price.

The bid price is always less than the asking
price and the gap between the bid price and the bid price is called the spread,
which is also one of the costs of opening up a position in any market.

For example, if the market window on your
trading platform quotes EURUSD at 1.13956/1.13961, this would mean that the bid
price is 1.13956 and the bid price is 1.13961.

When you go for a long time and’ buy’ on a
particular instrument, your place will be opened on the asking price and closed
on the bid price. On the other hand, if you go short or’ sell,’ your position
will be opened at the bid price and closed at the request.

Spread

The spread on the financial markets is the
difference between the selling (ask) price of the instrument and the sale (bid)
price of the instrument. When a contract is put on the market, the spread is
also the main cost of the transaction. The smaller the gap, the lower the trade
price. The wider the range, the higher the cost. You can also see the spread as
the minimum distance that the market needs to move in your favor, before you
can start earning a profit. 

For example, let’s say that our EURUSD
market is quoted at a purchase price of 1,0984 and a sale price of 1,0983, so
that the spread is calculated by subtracting 1,0983 from 1,0984-with a total
spread of 0.0001 or 1 pip. Once you have put a trade on the EURUSD market and
the market moves at least 1 pip to your advantage, that’s when your position
will start to generate profits. This is also the reason that when you start
trading, you’re going to start making a loss.

Stop
Loss

Experienced traders will testify that
prudent risk management is one of the keys to long-term success on financial
markets. Using a stop loss is one of the most popular ways for traders to
control their risks around the clock.

What’s
a Stop Loss Order?

Stop loss is a form of closing order that
allows the trader to designate a specific level on the market where, if prices
were to drop, trade would be stopped automatically by our systems, usually for
loss. This is where the title Stop Loss comes from, because the order
essentially prevents the losses.

How
Does Stop Loss Work in Practice?

Take a look at the example above. The
trader opened a long position on EURUSD in anticipation of an increase in value
above 1.13961, as shown in the first section. You’ll find a second line below
that of Stop Loss set at 1.13160. This means that if the market falls below
this level, the position of the trader will automatically be closed at a
loss-and therefore the trader will be protected from any further lower price
movements. A Stop Loss helps manage the risk and keep your losses to a
reasonable and regulated minimum.

While stop loss orders are one of the best
ways to ensure that your risk is managed and that potential losses are kept to acceptable
levels, they do not provide 100% security.

Stop losses are free to use and defend your
account against adverse market movements, but please be aware that they can not
guarantee your position at any time. If the market unexpectedly is unstable and
there are differences above your stop point (jumps from one value to the next
without trading at the intermediate level), it is likely that your place could
be closed at a worse rate than you requested. This is referred to as the value
slippage.

Guaranteed stop losses, which have no
chance of slipping and guarantee that if the market moves against you, the
place is closed at the stop loss rate you requested, are available free of
charge with the Basic account.

Take
Profit

A take profit order is an order that closes
the company once it reaches a certain level of profit. Once the take benefit
order is placed on a contract, the trade is closed at the current market value.
Although it prevents any further advance in revenue, it ensures a similar gain
after the rate has been achieved.

How
Do Take Profit Orders Work in Reality?

Let’s take a look at the example described
above. The trader opened a short position on EURUSD in anticipation of a
decrease in value below 1.13941, as shown in the first line. You’ll find a line
below that of Take Profit set at 1.12549. It means that if the market moves
towards this point, the role of the trader will immediately be closed at a
profit-and therefore the trader will be shielded from any further lower price
changes. Nevertheless, it also prevents any further income advance if the price
continues to fall. The basic benefit will be drawn from the table and the place
will be closed.