QQ 101, 2 min read

Forex basics

Foreign exchange is the trading of one currency for another. Prices come in pairs. EUR/USD at 1.1000 means one euro costs 1.10 US dollars. The first currency is the base, the second is the quote. Buying EUR/USD means buying euros and paying in dollars.

Pips

A pip is the standard small unit of movement. For most pairs it is the fourth decimal place, 0.0001. For pairs quoted in Japanese yen it is the second decimal place, 0.01.

EUR/USD moving from 1.1000 to 1.1025 is a move of 25 pips.

Lots

Trade size is counted in lots. One standard lot is 100,000 units of the base currency. A mini lot is 10,000 and a micro lot is 1,000.

On one standard lot of EUR/USD, one pip is worth:

100,000 x 0.0001 = 10 US dollars

So a 25 pip move on one standard lot is 250 dollars, for or against you.

Leverage and margin

One standard lot of EUR/USD at 1.1000 is a position worth 110,000 dollars. Brokers let you hold it with a fraction of that as a deposit, called margin. With 30 to 1 leverage the margin is one thirtieth:

110,000 / 30 = about 3,667 dollars

Leverage changes how small an account can hold the position. One pip is worth the same either way. A 100 pip move against one standard lot is 1,000 dollars whether your account holds 4,000 dollars or 400,000. On the small account that is a quarter of it.

Financing

Holding a currency position overnight earns or pays interest, because you are long one currency and short another. Brokers call this swap or rollover. It is small per day and adds up over months.

Further reading

• Bank for International Settlements. Triennial Central Bank Survey of Foreign Exchange and Over-the-counter Derivatives Markets.
• Hull, J. C. Options, Futures, and Other Derivatives. Pearson. The chapters on currencies and interest rate parity explain where financing costs come from.