Understanding Trading Terminology: Key Concepts for New Traders

Forex trading can be an intriguing concept to many people, especially those who aren’t afraid to take risks. However, if you’re to comprehend how it works, you’ll need first to understand the most commonly used beginner trading terms .

The reality is that trading terminology can seem like a whole new language to the uninitiated. With a plethora of different terms and jargon, the typical trading glossary can prove to be overwhelming for a beginner trader!

“Lost in trading jargon? Let’s make it easy!” In this guide, we will take you through the main trading terms to help you navigate the currency markets more easily and with renewed confidence. Read on to learn more.

Basic Trading Terms

Key Takeaways

Bull Market / Bear Market: These are market trends in trading: bull relates to rising bear to falling price movements.
Spread: It’s the difference between the bid and offer prices, often reflecting market liquidity.
Limit Order: This is a pre-set order to purchase or sell at a specific price and is useful for controlling entry/exit points.
Resistance / Support Levels: These are the price levels where market trends may pause or reverse.

Trading terms are the foundational language of the currency market. These are the terms and phrases that traders use to describe various aspects of the industry, including market conditions. Traders around the world use them to get a better understanding of the markets.

Below is a look at some of them:

Bull Market / Bear Market

These are market trends relating to rising (bull) and falling (bear) price movements.

Bull Market: It’s a market that is on the rise and whose economic conditions are generally favourable. This market is often typified by a sustained increase in asset prices. When looking at the equity markets, a bull market will signify a rise in the price of company shares. In such times, an investor can rest easy knowing that the uptrend will continue for an extended duration.

Bear Market: A bear market is the direct opposite of a bull market in that it denotes a declining economy. For traders to consider the market as being truly “bear,” it must have fallen by at least 20% or more from its recently recorded highs. Therefore, take note that when faced with a bear market, the share prices will be on a freefall.

Bid / Ask Price

The bid and ask price are the prices that the respective buyers are willing to pay and what the sellers are hoping to net.

Source: CFI

Traders use the term “bid” to refer to the highest price that an investor would be willing to pay to acquire a specified number of shares. On the other hand, the term “ask” refers to the lowest price that the seller would be willing to accept to offload their stock.

In most trading scenarios, the bid price will almost always be less than the “offer” or ask price. The resulting difference between the bid price and the offer price is what investors call the “spread.”

Spread

It refers to the difference between the bid and offer prices, often reflecting market liquidity.

Usually, the spread is the difference between the amount that traders are willing to pay for a stock (bid price) and the amount that sellers are willing to sell it for (ask price). This is what investors call the bid-ask spread . The spread signifies the cost of trading and will usually vary depending on liquidity and market conditions. In forex, the spread serves as the difference between the buy and ask price in pips and can be calculated by subtracting the bid price from the selling price.

For example, if you’re trading the GBP/USD pair at 1.3090/1.3095, you can calculate the spread as 1.3095 – 1.3090. The result is 0.0005 – or five pips.

Key Trading Metrics

Forex trading involves much more than buying and selling stocks and currency pairs. It’s about making informed trading decisions based on facts and numbers. If you’re to excel in trading, there are certain metrics that you’ll need to monitor on an ongoing basis.

The following is a look at some of these essential metrics:

Pip

A pip helps define the price movement of various currencies in FX markets. “Pip,” in this case, stands for “price interest point” or “percentage in point.” It is the smallest price move in forex.

In the world of trading, currency pairs are typically traded on a pricing convention that includes the big figures, also known as four decimal places. The pip, in this case, represents that last digit. As such, we can say that a pip is equal to 0.0001.

For example, if you’re trading the CAD/USD pairing and the exchange rate shifts from 1.2014 to 1.2015, the resulting change in value will represent a single pip.

Leverage

Leverage in trading involves using borrowed capital to invest in a security, stock, or currency. This is a concept that’s quite common in forex trading, where a trader borrows money from a broker to allow them to trade a larger position. As a result, leverage helps in magnifying your returns from positive movements in the currency’s exchange rate. But before you get too excited, you should note that leverage is a double-edged sword. What this means is that it can easily magnify your losses in the same way that it can enhance your profits. As a forex trader, you need to learn how to go about managing leverage and deploying risk management strategies to assist in mitigating forex losses.

Margin

Margin in trading refers to the collateral that you, as a trader, need to deposit with an exchange or broker to cover the risk you pose for them. You can create credit risk when you borrow capital from a broker to enter into a derivative contract, borrow financial instruments that you wish to sell short or buy stocks and other financial instruments.

Buying on margin happens when you purchase a financial instrument by borrowing the balance of your capital from a broker. Therefore, buying on margin refers to the initial payment that you’ll make to the broker in exchange for the asset. By doing so, you’ll be said to have used the marginal securities in your trading account as collateral.

Order Types

Brokers provide several types of orders as shown below:

Market Order

It is defined as an order to buy or sell immediately at the current price.

For example, if you’re trading the EUR/USD pair, and its price is 1.2140 while the offer price is 1.2142, it means that you’ll buy it at 1.2142

Please remember that depending on the prevailing market conditions, you may notice a difference between the selected price and the final price.

Limit Order

It refers to a pre-set order to buy or sell at a specific price and is useful for controlling entry/exit points.

A limit order in the FX markets is a direction to buy or offload a security or stock at a specified price or a better one. It’s a stipulation that allows you to gain better control of the prices at which your financial instruments will trade. This leaves you free to place a limit on either a buy or sell order.

Depending on your choice, this is what to expect:

A buy-limit order will only get executed at the specified limit price or a lower one.
A sell limit order can only be effected at the pre-set limit price or a higher one.

The one thing you must understand is that while the price may be guaranteed, the filing of your order won’t be. The takeaway here, therefore, is that a limit order will only get executed if the price satisfies the conditions set for it.

A market order is an alternative to the limit order, as it calls for your order to be executed at the current market without placing any limitations on the price.

Stop-loss Order

A stop-loss order refers to a type of order used by investors to lock in a profit position and limit their losses on an existing position. You can, thus, use it to control your risk exposure.

At this point, it’s important to mention that stop-loss orders are orders that have instructions on when to close a position. The instructions will explain when to buy or sell a security, which will typically happen when the asset in question reaches what is called a stop price.

Please note that a stop-loss order is quite different from a stop-limit order . The latter may not be executed, while the former will always get executed.

Technical Analysis Terms

Traders use technical analysis to evaluate statistical trends in forex trading, typically involving volume and price movements. It helps identify viable trading and investment opportunities.

The following are the most commonly used in technical analysis:

Trend

In trading, a trend refers to the overall direction of an asset’s price or the market in general. Trends, in technical analysis, are identified using price action or trendlines that highlight when the price movement is making lower swing lows coupled with lower swing highs for downtrends and the reverse for uptrends.

Many seasoned traders choose to trade in the same direction as the trend. However, there are contrarians who will usually opt to trade against a trend or seek to identify a reversal. Downtrends and uptrends occur in all markets, such as futures, bonds, and stocks. A trend can also happen in data, e.g., when economic data rises or falls from one month to the next.

Resistance / Support Level

‘Resistance’ and ‘support’ are trading terms used to describe two respective levels on a price chart. These are the levels that appear to limit the FX market’s range of movement. The resistance level, for example, is where the price will generally stop rising and begin to dip. This means that the support level is where the asset’s price will stop falling and begin rising. These two levels are a product of supply and demand.

Chart Showing Support and Resistance Levels . Source: Learning Centre

To identify the resistance and support levels, you can look at the following factors:

Historical price data
Technical indicators
Past resistance and support levels

Volatility

Market volatility is a term traders use to describe the extent of price fluctuations in the market. It assists in indicating the level of risk related to the price movements of a given security. Traders and investors calculate it to assess past price variations in a bid to predict future movements.

Volatility can be determined by either using beta or the standard deviation. The latter measures the amount of dispersion, while the former is calculated by using regression analysis. Some of the most common types of volatility include:

Implied volatility
Historical volatility

Practical Example: How These Terms Work Together In A Trade

Let’s look at a scenario where John, a seasoned trader, uses the terms mentioned above to trade the EUR/USD pair during a bullish run.

Market Analysis

John will need to start by analysing the EUR/USD pair. Given that it’s on a bull run, it means that the prices will have gone up. At this point, he expects this upward trend to continue based on strong economic data from the Eurozone.

Identifying Support And Resistance Levels

Having performed his analysis, the next step is to identify the support and resistance levels:

Support Level: John identifies a strong support level at 1.0800, where the price has previously bounced back up several times.
Resistance Level: He also spots a resistance level at 1.1000, where the price has struggled to move higher in the past.

Executing His Trade

John decides to go long on his chosen pair, believing the price will break through the resistance level.

He then sets a stop-loss at 1.0780, just below the support level, to minimize potential losses if the trade goes against him.

While at it, he remembers to set a take-profit order at 1.1050, targeting to capture profits if the price rises above the resistance level.

Using Leverage And Margin

Let’s say our trader’s available balance is $1,000. If he chooses to use a leverage ratio of 1:10, it means he has an opportunity to control a position size of up to $10,000. For him to open this position, his broker will require a margin. By using a leverage of 1.10, the required margin will be $1,000 / 10 = $100.

Executing A Market Order

Confident in his analysis, John proceeded to execute a market order that allowed him to buy the EUR/USD pair at the current price of 1.0850. Knowing that leverage is a double-edged sword, John carefully monitors the trade.

Outcome

The following are the two likely outcomes:

If the price rises to the take-profit level of 1.1050, John gets to earn a profit on his initial investment. Given his position size of $10,000, a 200-pip gain (from 1.0850 to 1.1050) equals $200.
If the price movements go against his trade to the stop-loss level of 1.0780, John will incur a loss of $70 (from 1.0850 to 1.0780).

In the example above, John used a bull market analysis to make a leveraged trade, making sure to set clear support and resistance levels, including using a stop-loss for risk management and executing a market order. By applying margin and leverage, he was able to amplify potential gains but also faced increased risk.

Conclusion

Understanding the key trading concepts is a crucial first step to becoming a profitable trader. By taking time to master the language of the market, you stand a better chance of navigating the trading industry with ease and confidence. The reality is that it’s only by understanding the trading glossary that you can truly make informed trading decisions. These are decisions that will help you maximize your potential for success even when trading in volatile market conditions. Make it a point to revisit this glossary even as you continue learning and navigating different markets.

To make sure that you don’t get overwhelmed, consider bookmarking this glossary for quick reference when trading.