One of the hallmarks of a successful trader is a proper understanding of the market including its terminologies. These terms are the language of operation in the forex market.
It has been observed that many Kenyan traders do not grasp the meaning of these terms. Words like leverage, pip, spread, online broker, lots, quote currency etc do sound like Greek or jargon to traders.
We will try to explain some commonly used market terminologies to the understanding of the layman in Kenya.
Market terminologies and their meaning
A market regulator is a statutory body that ensures the rules guiding market activities are followed and punish erring offenders of those rules.
In Kenya, the regulator of activities in the Capital market is the Capital Markets Authority (C.M.A). They are responsible for granting licences to brokers, formulating rules that guide market activities etc.
Forex Brokers SA explains that there are 2 major market regulators in Africa. These are FSCA in South Africa & CMA in Kenya. There are some financial providers that are regulated by both these regulators.
For example, some forex brokers in Africa like HotForex, Exinity Limited, Scope Markets are licensed with both FSCA & CMA. These brokerages generally have lower third-party risk due to their regulation with multiple regulators.
Also called a stock exchange, the securities exchange is a market where stocks, bonds, and other financial instruments are traded.
In Kenya, the Nairobi Securities Exchange (NSE) is the marketplace for trading securities and other financial instruments.
A broker is a sort of middleman between the buyer of equity and the seller. What this means is that brokers help facilitate trade between buyers and sellers. An online broker is a person who helps traders purchase and sell securities, stocks etc. using an online medium usually powered by the internet.
Online brokers could be stock brokers or forex brokers.
Stock Brokers are licensed by the Capital markets Authority (CMA) and they also have to apply as a trading member with NSE.
Online Forex Brokers in Kenya also have to be licensed with CMA and Interested traders should only trade via licensed brokers to ensure that their funds are protected. If you trade with an unregulated broker & there is no protection if you lose your funds.
A trading platform is software provided by brokers that give traders access to the financial markets.
Most brokers offer online, web-based, mobile apps or a combination of all three to their clients. In recent times, the MetaTrader4 has become the dominant platform provided by forex brokers to clients.
Spread is a fee or markup charged by brokers in Forex. It is the difference between the Bid and Ask price of a currency pair.
As a forex trader, you must have noticed that a currency's bid price is usually lower than its Ask price. Example BID/ASK price for EUR/USD = 1.1321/1.1325
Spread = 1.1321 – 1.1325 = 4 pips
The buy price is called the “Bid” price while its sell price is called the “Ask” price. The reason for this ranges from the volatility of the currency pair, size of the trade, the currency pair itself etc.
The Bid price is the price at which you can buy a unit of that currency. The Ask price is the lowest price for selling the currency.
This refers to a strategy employed by traders where they buy particular security like stocks, or in the forex market and sell just before the close of the market for that day. It is intraday trading when the securities are bought and sold within a single day.
This practise is very common among intraday traders who employ technical analysis to profit from the price movements of the securities. Day trading as a strategy is most common among those who trade currency pairs and stocks.
This is an acronym for “Percentage in Points”. Pip is the smallest movement between the Bid and Ask price of a currency pair according to the practices of the market. By this, we mean Pip is a unit of measurement used to describe the value of change in the price of a currency pair or the spread.
Except for the Japanese Yen (¥), the standard practice in quoting the exchange rate is in four decimal places. For example, if the EUR/USD Bid/Ask price is 1.1000/1.1001, the difference between Bid and Ask price is 1.1001 –1.1000= 0.0001 also expressed as 1 pip, ignoring the zeros.
This term is most common in derivatives trading. It is used in Futures, Options, and forex trading.
For example, in forex, it refers to the standard amount or quantity of a unit of a currency pair in trade. Since forex price movements are calculated in pips and you can't just buy one pip, lots were created so that traders can buy currencies in standard quantities.
There are four lot sizes- the standard lot, mini, micro and nano lots. The standard lot is equal to 100,000 currency units, mini lot is 10,000 currency units, micro lot is 1,000 currency units and Nano lot 100 currency units.
The base currency is the currency that appears first in a currency pair. Take the EUR/USD for example, the EUR is the base currency since it appears first.
The base currency is also called the transaction currency. This is because it is the one being bought. When you trade the EUR/USD for example, you buy EUR and sell USD simultaneously.
The quote currency is the opposite of the base currency. It is the second currency in a currency pair. The quote currency is used to buy the base currency. In the AUD/CAD currency pair, the CAD is the quote currency. It is also called the counter currency.
Let’s imagine a trader has Sh10,000 to trade a particular instrument. However, he wished to use more than Sh10,000 for his trade. The broker then lends the Sh100,000 to trade. That borrowed funds from the broker to the trader to trade a particular instrument and increase his profit is called leverage.
Simply put, leverage is the use of borrowed funds from a broker to trade in the financial market and amplify one's profit. However, as good as leverage seem, it can be disastrous if a trader's speculation goes south.
Leverage is expressed in ratios like 1:100, 1:1000 etc. Most brokers in Kenya offer leverage of as high as 1:400. What this means is that Sh1 can be used to trade Sh400 worth of the instrument.
Margin is inversely related to leverage. It refers to the deposit made in order to open a trade and keep it open. It is a fraction of the full value of the trade you open.
For example, if the leverage of an instrument is 1:100 the margin in percentage is 1/100 = 1 per cent should the trader wish to open a trade worth Sh10,000 he will have to make a deposit of 1 per cent of 10,000 which is Sh100.
That Sh100 is called the margin.
A derivative is a financial instrument that derives its value from an underlying Asset or group of Assets such as equity, currency, commodities etc.
Examples of derivative products include futures, forwards, options, swaps, CFDs etc.
Contract for Difference (CFDs)
This refers to an agreement between the trader and broker to speculate on the trajectory of a particular instrument on the market. The net difference is usually settled in cash.
In CFD trading, the trader does not actually buy or own the instrument, they only bet on projections on the future of the instrument.
CFDs are over the counter (OTC) derivative products that enable a trader to speculate on price fluctuations of an asset. The idea is for the trader to profit from the price increase (going long) or decrease (going short) of the asset.
CFDs are leveraged products so the trader can use margin to trade. These are generally high-risk instruments
CFDs are not traded on an exchange. These are generally offered by forex brokers.
Over The Counter (OTC)
Over The Counter means that the trading is not carried through any centralised exchange.
What this means is that the OTC market & the agreement is arranged by brokers and dealers, and the parties outside of the exchange, rather than through the exchange.
The risk can be very high depending on the counter-party, and this could be risky for the trader trading those instruments.
In our explanation of margin, we said that margin is the funds deposited in order to open a trading position that is greater than your funds available. However, when the trade goes margin falls below what is required for the trade opened, you'll receive a margin call.
A margin call is a notification from your broker that your margin has fallen below the minimum required for the trade you opened. In recent times, this notification come in form of a text or email. In the past, it used to be an actual phone call.
This is a risk management strategy whereby a trader opens a trading position with the intent of protecting an existing position against loss. The primary reason for hedging is to reduce risk.
Stop Loss Order
This is a feature provided by brokers to limit losses when the market is moving against a trader's projection. It is usually placed at the opening of trade.
For example, a forex trader opens a EUR/USD trade at 1.1160, he might set up a stop loss at 1.1100. Immediately, the price falls to 1.1100, he automatically exits or closes the trade and counts his losses.
This is an order to buy or sell a security at a predefined price.
Limit orders can be set via a broker’s platform and can be used to place buy or sell orders on any instrument.
By: Rahul Sharma.
Content provided by Forex Brokers.