FOREX currencies are traded in much smaller divisions than cash. Whereas the
smallest division in US cash is the penny ($0.01), US currency can be
traded on the FOREX in divisions of $0.0001. This smallest division is
called the pip (short for Price Interest Point - sometimes
just called 'points'). Since currencies are traded in large lots of
(say) $100,000 - small movements in value can generate substantial
profits and losses. In a lot of US$100,000 one pip is worth $10 so an
increase in 40 pips (4/10 of one cent) can generate a profit or loss of $400.
How Foreign Currencies are Traded: Units and Standard Lots
Currencies are traded in lots of various sizes. The standard lot is 100,000 units of the base currency. A unit
is the currency name e.g. one unit of US dollars is the dollar. So a
standard lot of US currency is worth $100,000. FOREX trades can have
lots of various sizes - a mini lot is 10,000 units, but the most trades
are done using standard lots.
Value of a Pip
Various currencies have different sized
pips. The US dollar is expressed in pips of 0.0001 while the Japanese
yen is expressed in pips of 0.01. The value of a pip depends on the
size of a lot and the currency pair traded. Currency pairs with USD as
the quote (second) currency (e.g. CAD/USD) always have a pip value of
$10 per standard lot or $1 per mini lot. A pip value calculator can be
used to calculate other currencies.
FOREX Order Types
A trader has at his or her disposal different types of orders to make
FOREX trades. A clear understanding of each type of order is necessary to be
a successful FOREX trader.
Market
Order - is an order to
buy or sell at the current market price. They can be used to enter or
exit a trade. Market orders should be used with care because in
fast-moving markets there may be a difference between the price seen at
the time a market order is given and the actual price of the
transaction. This is due to slippage - the amount the market
moves in the few seconds between giving an order and having it
executed. Slippage could result in a loss or gain of several pips.
Limit Order
- is an order to buy or sell at a certain limit. They can be
used to buy currency below the market price or sell currency above the
market price. When buying, your order is executed when the market falls
to your limit order price. When selling, your order is executed when
the market rises to your limit order price. There is no slippage with
limit orders.
Stop Order
- is an order to buy above the market or to sell below the
market. They are most commonly used as stop-loss orders to limit losses
if the market moves contrary to what the trader expected. A stop-loss
order will sell the currency if the market falls below the point set by
the trader.
One Cancels the Other
(OCO)
- this type of trading order is used when placing a limit order and a
stop-loss order at the same time. If either order is executed the other
is cancelled, allowing the trader to make a transaction without
monitoring the market. If the market falls, the stop-loss order will be
executed, but if the market rises to the level of the limit order, the
currency will be sold at a profit.
Example OCO Transaction:
Buy: 1 standard lot EUR/USD @
1.3228 = $132,280
Pip Value: 1 pip = $10
Stop-Loss: 1.3203
Limit: 1.3328
This is an order to buy US dollars at 1.3328 and to sell them if they
fall to 1.3203 (resulting in a loss of 25 pips or $250) or to sell them
if they rise to 1.3328 (resulting in a profit of 100 pips or $1,000).
Here's another example:
The current bid/ask price for US dollars
and Canadian dollars is
USD/CDN 1.2152/57
...meaning you can buy $1 US for 1.2152 CDN or sell 1.2157 CDN for $1
US.
If you think that the US dollar (USD) is
undervalued against the Canadian dollar (CDN) you would buy USD
(simultaneously selling CDN) and wait for the US dollar to rise.
This is the transaction:
Buy USD: 1 standard lot USD/CDN @ 1.2157 = $121,570 CDN
Pip Value: 1 pip = $10
Stop-Loss: 1.2147
Margin: $1,000 (1%)
You are buying US$100,000 and selling CDN$121,570. Your stop loss order
will be executed if the dollar falls below 1.2147, in which case you
will lose $100.
However, USD/CDN rises to 1.2192/87. You
can now sell $1 US for 1.2192 CDN or sell 1.2187 CDN for $1 US.
Because you entered the transaction by
buying US dollars (buying long), you must now sell US dollars and buy
back CDN dollars to realize your profit.
You sell US$100,000 at the current USD/CDN
rate of 1.2192, and receive 121,920 CDN for which you originally paid
CDN$121,570. Your profit is $350 Canadian dollars or US$287.19 (350
divided by the current exchange rate of 1.2187).
