In today’s Smart Money Club Financial Basics lesson, we are learning Forex terminology needed to take your trading to the Power of X.
What’s a pip?
Unlike stock price movements, which are measured in recognizable currency units such as cents or yen, forex changes are measured in tiny units called pips.
For example, if the GBP/USD price moves from 1.18360 to 1.18370, that 0.0001 USD rise in value represents one pip.
For the majority of major currency pairs, a pip is a one-digit move in the fourth decimal place.
One exception is where the Japanese yen is the counter currency (right hand). Here the second decimal place is the one to watch.
Any additional decimal places shown in the price are known as pipettes of fractional pips.
Quiz 1
If the USD/CAD price moves from 1.19627 to 1.19717, how many pips has it moved?
A. 9
B. 11
C. 90
D. 110
The quiz answer can be found at the end of the lesson.
What is a ‘lot’?
Each single pip movement in a forex price is only worth a tiny amount. So, to take advantage of these small changes in value, forex is traditionally traded in large batches called lots.
A standard lot comprises 100,000 units of currency. You may also come across mini-lots, 10,000 units, and micro-lots, 1,000 units.
| Lot | Units of currency |
| Standard | 100,000 |
| Mini | 10,000 |
| Micro | 1000 |
Small investors generally won’t have access to such large amounts of money, so many forex brokers allow their clients to trade with leverage.
Leverage means you can open a large position with a relatively small deposit – called margin. However, the profit or loss is based on the full position, so gains or losses could far exceed this deposit amount. We will cover leverage in more detail in Smart Money Club’s advanced courses.
Major pairs
You could theoretically exchange any currency for any other currency, which means potential forex pairs are vast. You could speculate on the price of two exotic currencies, the Armenian dram versus the Zambian kwacha (AMD/ZMW), if there was a broker willing to trade this pair.
However, the majority of forex trades use a few select currency pairs called the majors. What defines a major pair varies widely, but most traders agree that the following six apply; they account for over 80% of global forex trades:
| Currency pair | Currency names |
| EUR/USD | Euro / US dollar |
| USD/JPY | US dollar / Japanese yen |
| GBP/USD | Sterling / US dollar |
| AUD/USD | Australian dollar / US dollar |
| USD/CAD | US dollar / Canadian dollar |
| USD/CNY | US dollar / Chinese Yuan |
All these pairs include the US dollar, by far the most traded currency in the world.
Minor and exotic pairs
Currency pairs traded less frequently are known as minor currency pairs, cross-currency pairs, or simply crosses, mainly if the US dollar isn’t involved. The most popular minor pairs will contain the euro (EUR), British pound (GBP), or the Japanese yen (JPY).
There are also exotic or emerging pairs. These generally consist of one major currency against a small or emerging economy’s currency, for example, EUR/MXN (euro vs. Mexican peso) or GBP/PLN (British pound vs. Polish zloty).
Finally, there are forex classes based on a region, such as Scandinavian or Australasian pairs. The EUR/NOK (euro vs Norwegian krona) is a Scandinavian pair and the AUD/NZD (Australian dollar vs New Zealand dollar) could be an Australasian pair.
Quiz 2
1. What class is the following currency pair?
NOK/SEK?
A. Australasian
B. Scandinavian
C. Exotic
2. What class is the following currency pair?
USD/JPY?
A. Major
B. Minor
C. Exotic
3. What class is the following currency pair?
GBP/HUF?
A. Major
B. Minor
C. Exotic
4. What class is the following currency pair?
AUD/NZD?
A. Australasian
B. Scandinavian
C. Exotic
5. What class is the following currency pair?
EUR/CAD?
A. Major
B. Minor
C. Exotic
Answers to the quiz can be found at the end of the lesson.
Forex market drivers
Why do currency prices change?
Currencies indicate the health of the country/region they represent. Placing a trade hoping a particular currency will rise is a bet on that country’s economy.
Generally, the stronger a country’s economy, the stronger its currency will be compared to another currency.
Therefore, the factors affecting a country’s economy tend to have the most significant influence on its currency’s price; including:
- Interest rates
- Inflation rates
- Governmental/monetary policy
- Imports and export demand
- Economic statistics, including growth figures, unemployment, sales, and manufacturing data
Lesson summary
Forex movements are measured in pips. For most pairs, a pip is a fourth decimal one-digit move while the JPY as a counter currency is a second decimal change. Forex is traded in standard lots of 100,000 units, and pairs are classified as major, minor, or exotic. The stronger a country’s economy, the stronger its currency will generally be.
In our next Smart Money Club Financial basics lesson, we will be introducing you to commodities.
Quiz 1 Answer
- A: A pip is a move in the fourth decimal place for this pair. So 71 – 62 = 9 pips.
Quiz 2 Answers
1. B
2. A
3. C
4. A
5. B
