Terms You Must Know When Trading Forex (Part 2)

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After part 1, today, we will continue to learn about common and must-known terms in Forex trading such as Bid, Ask, Spread, Equity, Margin, etc.

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What are the terms “Bid”, “Ask”, “Spread” in Forex?

What is the Bid price?

The BID price is the price that the platform accepts to BUY from you, aka the price you will SELL to the market. That’s the best selling price at which you can sell.

In the quote, this price is the price that precedes.

For example, If the quote for GBP/USD is 1.2892/93, the BID price will be 1.2892. This means if you sell this currency pair, you will execute the order at 1.2892.

What is the Ask price?

The ASK price is the price that the platform accepts to SELL to you, aka the price you will BUY from the market. That’s the best buying price at which you can buy.

This price is the second one in the quote.

For example, If the quote for USD/JPY is 105.25/26, the ASK price will be 105.26. This means if you buy this currency pair, you will execute the order at 105.26.

What is Spread?

SPREAD is the difference between the BID and ASK.

SPREAD = ASK – BID

Some characteristics of SPREAD:

+ SPREAD is calculated by pips, decided by the platform and market.

+ The higher the SPREAD is, the more disadvantage the investor will suffer. Platforms charge via the SPREAD.

+ To attract investors, some platforms will adjust the SPREAD very low, or even to 0. At this time, platforms will collect fees from the Commission (commission per trading order).

• Therefore, you need to be alert to choose a reputable platform with a low spread and commission.

What are Balance, Equity, Margin, Free Margin, Margin level terms in Forex?

Balance

Balance is the initial balance in your account. Or it can be simply understood that this is the CASH amount in your account.

For example, If you deposit $1000 into a new account, your balance will be $1000. If you open a new order, your balance will not be affected until the order is CLOSED.

Your balance will only change in the 3 following ways: 

1. When you deposit money into your account.
2. The time when you close an order.
3. When you hold the order overnight. At this time, you will normally receive/pay the swap.

Since we have just mentioned swaps, what is the “swap”?

Swap is the fee you will receive or pay at the end of the day if you keep a transaction overnight.

If you get a swap, then that amount will be added to your balance.

If you have to pay a swap, that amount will be deducted from your balance.

Whether you do not open high-volume orders, these swaps are usually not much but can increase over time.

Equity

The term “Equity” represents the current value of your trading account and the fluctuations in your Forex account. It is the total account balance and all profits/losses from open orders.

When your current transactions increase or decrease in value, it is your equity.

Equity calculations:

+ If you don’t open any orders then Equity = Balance.

+ If you are opening an order:

 Equity = Balance + Profit / Loss of orders.

For example, Your balance is 1000 USD. The total profit of your open orders is 50 USD.

Then, Equity = 1000 + 50 = 1050 USD.

Margin

Margin is collateral money.

When trading Forex, you only need to place a small amount of capital to open and maintain new orders. This capital is considered margin. Margin can be viewed as collateral or deposit that you need to have to open a position or keep it open.

The amount of margin depends on the leverage you use.

For example, If you buy 1 lot of GBP/USD and use the 1:500 leverage, then you must have a margin of 100,000/500 = 200 USD.

Remember that margin can be a double-edged sword because it helps to make big profits while, at the same time, it can create big losses. This is because the order is based on the full value of the transaction, not just the amount needed to open it.

Free Margin

Free Margin is the amount of money in a trading account that has not been used as collateral. This amount can be used to execute any transaction such as withdrawals or opening new orders.

Formula for calculation: Free Margin = Equity – Margin.

Margin level

Margin level nghĩa là mức ký quỹ. It is the percentage (%) based on the amount of equity compared to the amount of the margin used. The lower the margin level is, the less unused margin will be. This could lead to something very bad like a Margin call or a Stop out.

The formula for calculating Margin level:

Margin level = (Equity/Margin) x 100% = Percentage (%)

For example, Your account has equity of 10,000 USD. You place a position with a margin of 2500 USD. 

Now, Margin level = (10,000/2500) x 100 = 400%

Paying attention to the margin level is of utmost importance. It allows traders to see if there is enough money in the account to open new trading positions.

In conclusion

We have covered the most common and necessary terms in Forex trading.

In the next article, I will introduce and explain to you the types of Forex orders and how to use them.

Wishing everyone a good and successful transaction.

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