CURRENCY TRADING STRATEGIES GLOSSARY OF TERMS

Here you will find definitions for many of the terms used throughout the Forex Course and in many currency trading strategies that Peter Bain discusses on this site.

A | B | C | D | E | F | G | H | I | J | K | L | M | N

O | P | Q | R | S | T | U | V | W | X | Y | Z

A

Appreciation - A currency ‘appreciates’ when its price strengthens in response to market demand.

Arbitrage – Taking advantage of small price differentials between markets through the purchase or sale of an instrument, and the simultaneous taking of an equal and opposite position in a related market.

Around – Quoting jargon used by dealers when the forward premium/discount is near parity. For example, “two-two around” means 2 points to either side of the present spot.

Ask Rate - The rate a financial instrument is offered for sale at (as in bid/ask spread).

Asset Allocation – To meet an investor’s objectives, this investment practice divides funds among different markets to achieve diversification for expected returns and/or risk management purposes.

Auctioning System - A trading platform in which a trader requests a price from a pricing source, and then makes a buy/sell decision based on the quote offered. A matching engine is one in which a trade is executed only if both sides of the trade can be filled at the time of the buy/sell request.

B

Back Office - The departments and processes that exist to settle financial transactions.

Balance of Trade - The value of a country’s exports less its imports.

Base Currency - The currency in which an issuer or a trader maintains its book of accounts. In the FX market, the U.S. Dollar is normally the ‘base’ currency for quoting purposes. This means that quotes are expressed as a unit of $1 USD per the other currency quoted in the pair. The primary exceptions to this rule are the Australian Dollar, the British Pound, and the Euro.

Bear Market - A market where prices are declining.

Bid Rate - The rate at which a trader can buy a currency.

Bid/Ask Spread - The difference between the bid and offer prices.

Big Figure - Dealer expression for the first few digits of an exchange rate. These digits are omitted in dealer quotes, as they rarely change in normal market fluctuations. For example, a USD/Yen rate would be quoted verbally without the first three digits - i.e., “30/35” – instead of 107.30/107.35.

Book - The summary of a desk’s or trader’s total positions.

Broker - An individual or firm that puts buyers and sellers together for a fee or commission, and therefore acts as an intermediary. In contrast, a ‘dealer’ commits capital and takes one side of a position, and closes out the position in a subsequent trade with another party to hopefully earn a spread (profit).

Bretton Woods Agreement of 1944 - An agreement that created fixed foreign exchange rates for the major currencies, provided for central bank intervention in the currency markets, and pegged the price of gold at US $35 per ounce. President Nixon overturned the Bretton Woods agreement in 1971, and established a floating exchange rate for the major currencies.

Bull Market - A market where prices are rising.

Bundesbank - Germany’s Central Bank.

C

Cable - The Sterling/US Dollar exchange rate, which got its name by virtue of being transmitted via a transatlantic cable beginning in the mid 1800s.

Candlestick - A bar that shows the trading range for the day, as well as the opening and closing prices. If the opening price is higher than the closing price, the rectangle in between the open and close price is shaded. If the close price is higher than the open price, that area is not shaded.
Central Bank - A government or quasi-governmental organization that administrates a country’s monetary policy. For example, the U.S. central bank is the Federal Reserve, and the German central bank is the Bundesbank.

Chartist (or Technical Trader) - An trader who uses charts and graphs, and interprets historical price data in order to find trends, and predict future movements.

Clearing - The process of settling a trade.

Contagion - The phenomenon of an economic crisis spreading from one market to another. Political instability in Indonesia in 1997 caused high volatility in their domestic currency, the Rupiah. The contagion spread from there to other Asian emerging currencies, and then to Latin America. It is now referred to as the ‘Asian Contagion.’

Collateral - Something given as a guarantee of performance, or to secure a loan.

Commission – A transaction fee charged by a broker.

Confirmation - A document exchanged by two counterparts to a transaction that outlines the terms of that transaction.

Contract - The standard unit of trading.

Counterparty - One of the counterparts (participants) in a financial transaction.

Country Risk – Risk related to a cross-border transaction, including legal and political conditions.

Cross Rate - The exchange rate between two currencies considered non-standard in the country where the currency pair is being quoted. For example, in the U.S., a GBP/JPY quote is considered a cross rate, whereas in UK or Japan it is one of the primary currency pairs traded.

Currency - Any form of money issued by a central bank or government, and used as legal tender, and a basis for trade.

Currency Risk - The probability of an adverse change in exchange rates.

Day Trading – Positions opened and closed the same trading day.

D

Dealer - A ‘dealer’ commits capital and takes one side of a position, and closes out the position in a subsequent trade with another party to hopefully earn a spread (profit). In contrast, a broker is an individual or firm that puts buyers and sellers together for a fee or commission, and therefore acts as an intermediary.

Deficit - A negative balance of trade or payments.

Delivery - Both counterparts make and take actual delivery of the currencies being traded.

Depreciation - A fall in the value of a currency.

Derivative – A contract whose value changes in relation to the price movements of a related or underlying security, future or other physical instrument. An option is the most common derivative instrument.

Devaluation - The downward adjustment of a currency’s price.

E

ECNs (Electronic Communication Networks), also called matching systems, bring together buyers and sellers. However, there is no guarantee that a trade will be executed, nor at a fair market price. Traders often must wait until the market opens the following day to receive a tighter spread

Economic Indicator - A government-generated statistic that reflects current economic growth and stability. Such indicators include employment rates, Gross Domestic Product (GDP), inflation, retail sales, etc.

Electronic Commission Network (ECN) - An ECN system matches buy-side and sell-side orders. ECNs (also called matching systems) bring buyers and sellers together. However, there is no guarantee that every trade will be executed, nor at a fair market price. Quite often, a trader will have to wait until the market opens the following day in order to receive a tighter spread.

End Of Day Order (EOD) - An order to buy or sell at a specified price, which remains open until the end of the trading day.

European Monetary Union (EMU) - The principal goal of the EMU was to establish a single European currency called the Euro. This officially replaced the national currencies of the member EU countries in 2002. The transitional phase to introduce the Euro began January 1, 1999 and lasted for three years. Now that the Euro exists as a banking currency, paper financial transactions and foreign exchange are done in Euros. The Euro coins and notes entered circulation after the transition period. Only Euros became legal tender for EMU participants effective July 1, 2002, and the national currencies of the member countries ceased to exist at that time. The current members of the EMU are Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal, and Spain.

EURO - The currency of the European Monetary Union (EMU), which is a replacement for the European Currency Unit (ECU).

European Central Bank (ECB) - The Central Bank for the new European Monetary Union.

F

Federal Deposit Insurance Corporation (FDIC) - The regulatory agency in the U.S. responsible for administering bank depository insurance.

Federal Reserve (Fed) - The Central Bank for the United States.

Flat/square - A position that has been reversed - e.g., you bought $500,000 and then sold $500,000, thereby creating a neutral (flat) position.

Foreign Exchange - (Forex, FX) - The simultaneous buying of one currency, and selling of another.

Forward - The pre-specified exchange rate for a foreign exchange contract to be settled at some agreed future date, based on the interest rate differential between the two currencies involved.

Forward points - The pips added to or subtracted from the current exchange rate to arrive at a forward price.

Fundamental Analysis - Analysis of economic and political information in an effort to determine future price movements in a financial market. Opposite of Technical Analysis.

Futures Contract - An obligation to exchange a good or instrument at a set price on a future date. The main difference between a Future and a Forward is that Futures are typically traded over an exchange (Exchange-Traded Contacts – ETC), whereas forwards are considered Over-The-Counter (OTC) contracts. An OTC is any contract that is NOT traded on an exchange.

G

Good-’Til-Cancelled-Order (GTC) - An order to buy or sell at a specified price, which remains open until filled, or until the client cancels it.

H

Hedge - A position or combination of positions designed to reduce the risk of the primary position.

I

Inflation - An economic condition in which prices for consumer goods rise, thereby eroding purchasing power.

Initial Margin - The initial deposit of collateral required to enter into a position as a guarantee on future performance.

Interbank Rates - The Foreign Exchange rates at which large international banks quote other large international banks.

L

Leading Indicators - Statistics that are used to anticipate future economic activity.

Leverage - Market makers allow greater leverage than do the equities, futures or options markets. Market makers’ trading platforms are designed to effectively monitor and control risk exposure in real-time, with an extreme degree of precision.

Traders can engage 10:1 leverage (or even higher), without risking a margin call. Leverage can work against you. This high degree of leverage can lead to large losses, as well as gains, if you do not implement a proper risk management strategy. That is why you are encouraged to use tight stops.

Leverage of 100:1 is commonly available from online FX dealers, which substantially exceeds the common 2:1 margin offered by equity brokers. At 100:1, traders post $1000 margin for a $100,000 position, or 1%.

Leverage is essential in the Forex market, because the average daily percentage move of a major currency is less than 1%. However, the average daily range, in ‘pip’ terms, far exceeds the range achievable in equities markets.

LIBOR - The London Interbank Offered Rate, which is used by banks when borrowing from another bank.

Limit order - An order stipulating the maximum price to be paid, or the minimum price to be received. For instance, a limit order to buy would be at a price below 102 – i.e., 101.50 – if the current price of the USD/YEN pair is 102.00/05.

Liquidity – A market’s capability of accepting a large transaction with minimal, or no, impact on price stability.

Liquidation - The execution of an offsetting transaction to close an existing position.

Long position - A position that is taken with the expectation that it will appreciate in value if market prices increase.

M

Margin - The required equity that a trader must post as collateral for a position.

Margin call - A request from a broker or dealer for collateral or additional funds to protect performance on a position that has gone wrong.

Market Maker - A dealer who quotes bid and ask prices, and makes a two-sided market for a financial instrument.

Market Risk - Exposure to changes in market prices.

Mark-to-Market - Process of re-evaluating open positions with current market prices. The new values then determine margin requirements.

Matching Engine - A matching engine is one in which a trade is executed if both sides of the trade can be filled at the time of the buy/sell request. An auctioning system is one in which a trader requests a price from a pricing source, and then makes a buy/sell decision based on that quote.

Maturity - The date of expiry or settlement for a financial instrument.

O

Offer - The rate a dealer sells a currency at.

Offsetting Transaction - A trade that cancels or offsets some, or all of, the market risk of an open position.

Over-the-Counter (OTC) - A transaction not conducted over an exchange. The over-the counter nature of the FX market eliminates clearing and exchange fees, and thereby lowers transaction costs. Online trading technology gives direct access to market maker prices, and this in turn also lowers transaction costs, and eliminates commission fees. In addition, currency trading entails spreads that are narrower than those found in the equities markets (especially after-hour markets). This is because equity traders are more exposed to liquidity risk, and this results in wider dealing spreads.

Overnight - A trade that is open until the next business day.

One-Cancels-the-Other-Order (OCO) - One part of two orders is executed, and the other is automatically cancelled.

Open Order – An order that executes when a market hits its designated price. Usually associated with Good-’Til-Cancelled-Orders.

Open Position - A deal not yet reversed or settled with a physical payment.

P

Pip - Digit added to or subtracted from the fourth decimal place to the right - i.e., 0.0001. The size of the bid/ask spread: Regardless of deal size, Forex dealing spreads are normally five pips, or less (a pip being .0005 U.S. cents, or less). In general, the width of the spread in a FX transaction is less than 1/10 that of a stock transaction. Also called Points or Ticks.

Political Risk - Exposure to changes in governmental policy, which will negatively impact an investor’s position.

Position - The netted total holdings of a given currency.

Premium - The amount by which the forward or futures price exceeds the spot price in the currency market.

Price Transparency - Describes quotes to which every market participant has equal access to.

Q

Quote - An indicative market price, which is normally used for information purposes only.

R

Rate - The price of one currency in relation to another. Typically used for dealing purposes.

Re-quote - A broker backs reneges on his offer, and then offers a new higher price.

Resistance - In technical analysis, refers to a specific price level at which there is a propensity for traders to sell. Opposite of Support.

Revaluation - Increase in the exchange rate for a currency due to central bank intervention. Opposite of Devaluation.

Reverse Auction - FXall and Atriax have a reverse auction business model, in which corporate clients request a price, and then several banks submit bids for that trade.

Risk - Exposure to uncertain change, usually assumed to be of an adverse nature.

Risk Management - Financial analysis and trading techniques used to control and/or reduce exposure to risk.

Roll-Over - Process wherein the settlement of a deal is rolled forward to another value date. The cost of such a process is determined by the interest rate differential between the two currencies.

S

Settlement – A trade is entered into the books, including records of the counterparts to a transaction. The settlement of currency trades may or may not actually involve the physical exchange of one currency for another.

Shading – Traders, engaged in phone-based trading, have to request a quote for each transaction. Accordingly, the dealer can read the client’s position, and shade the price in the dealer’s favor. Shading can range from just a few pips for a large client, and up to 50 pips, or more, for a smaller transaction.

Short Position - An investment position that benefits from a decline in market price.

The ability to sell currencies without any restrictions is another distinct advantage the FX has over equity trading. In the U.S. equity markets, it is much more difficult to establish a short position due to the Zero Up-tick rule. This is because traders can only short a stock when the preceding trade was equal to, or lower than, the price of the short sale.

Unlike the equities markets, profit potential exists in the foreign exchange market, regardless of whether a trader goes long or short, or whether the market is going up or down. Equities are often considered the purview of buyers, since market regulations and rules are structured such that short selling is discouraged – i.e., selling shares one does not own. There is no structural bias to the currency market, since currency trading involves the buying of one currency, and the selling of another. This means that a trader has an equal opportunity to profit either in a rising or falling market.

Spot Price - Current market price. Settlement of spot transactions usually takes place within two business days.

Spread - The difference between the bid and offer prices. Dealing spreads are typically five pips or less.

Sterling - British Pound.

Stop Loss Order - Open position automatically liquidated at a specific price. Used to minimize exposure to loss, if the market moves against a trader’s position. As an example, if a trader is long USD at 156.27, implementing a stop loss order for 155.49 would limit any potential loss should the dollar depreciate, say below 155.49.

Support - In technical analysis, refers to a specific price level at which there is a propensity for traders to buy. Opposite of Resistance.

Swap - Simultaneous sale and purchase of the same amount of a given currency at a forward exchange rate.

T

Technical Analysis - Analysis of market data – i.e., historical price averages and trends, open interest, volume, etc. – in an effort to determine future price movements in a financial market. Often referred to as the study of charts. Opposite of Functional Analysis.

Currencies rarely spend much time in tight trading ranges, and have a tendency to develop strong trends. On a regular basis, an astute trader can quite easily identify new trends and breakouts, which provide for multiple opportunities to take positions. Most market makers provide clients with free real-time charting packages.

Tomorrow Next (Tom/Next) - Simultaneous buying and selling of a currency for delivery the following day.

Transaction Cost - Cost of buying or selling a financial instrument.
Transaction Date - Date on which a trade takes place.

Turnover - Total dollar value of all executed transactions within a given period of time; volume.

Two-Way Price - Both a bid and offer rate are quoted for a FX transaction.

U

Up-tick - New price quote at a price higher than the preceding quote.

Up-tick Rule - Regulation in the U.S., whereby a security cannot be sold short unless the last trade prior to the short sale was at a price lower than the price at which the short sale is executed. You can’t go short price is falling. U.S. securities regulators are looking at clamping down on short-selling with new rules. These new rules would be designed to prevent cornering the market in a company’s stock.

U.S. Prime Rate - Interest rate at which U.S. banks will lend to their prime corporate customers

V

Value Date - Date on which counterparts to a financial transaction agree to settle their respective obligations – i.e., exchanging payments. The value date is normally two business days forward for spot currency transactions. Also known as maturity date.

Variation Margin - Funds a broker requests from a client to have the required margin deposited. The term usually refers to additional funds that must be deposited as a result of unfavorable price movements.

Volatility (Vol) - Statistical measure of a market’s price movements over time.

W

Whipsaw - Sharp price movement is quickly followed by a sharp reversal in a highly volatile market.

Y

Yard – Billion.