Basic Forex terminology: lot, leverage, stop loss

Orientation in a new environment is not easy. Perhaps all professions have a minimum terminology outsider won’t understand. Forex is no exception. Let’s take a look at some basic jargon and explain a few terms in our business.

What is “a lot”

A lot is a basic buying or selling investment volume. One lot represents 100 000 units of basic currency, typically US dollar. In the olden days, lots were the only unit to trade with. This was a drastic limitation to small traders. Today, it’s a mere term as you can trade in smaller volumes (micro-lots and nano-lots) or use leverage.

For example, one nanolot equals 100 units. If you don’t use leverage, the number of lots is the only variable you can choose to change the size of investment.

If you open a position equal 1 lot for the currency pair EUR/USD each pip will represent a difference of USD 9.99734. This means that a price movement by 10 pips in your favour will earn you approximately USD 100.

What is margin and leverage

A lot is closely related to two further terms:  margin and leverage. Most of you have already heard of  leverage trades. If the broker offers you a leverage of 1:100 this means that with USD 1 000 you will be allowed to control up to USD 100 000. One lot will cost you USD 1 000 instead of USD 100 000.

What are these things good for? Of course, for increasing your profit.

If you sell e.g. EUR/CZK without using a leverage and the size of your position is 1 micro-lot (1000 units) and Czech Koruna devaluates by one CZK, you will earn CZK 1 000. Using a leverage of 1:100 the same money will generate you 1 lot – so you have earned hundred times your investment, that is CZK 100 000, which is tempting.

Remember that this rule also works in the opposite direction. If your position includes 1 lot (EUR 100 000) and CZK gets stronger by one CZK you will lose CZK 100 000.

Some brokers allow trading with a 1:1 or 1:400 leverage. But as far as I know,  CySEC recently ordered a maximum leverage of 1:10 for all licensed brokers. The more one should be cautious about which broker to chose for trading.

TIP: Would you like to know the meanings of some more terms from the world of binary options / Forex. Check out our glossary of terms.

Because leverage trading is used often, the broker will, with each trade, block part of your account called margin. This will protect the broker from a potential loss. As long as the broker feels that the trade is in jeopardy, tehy may make a margin call = to ask you to add cash to your trading account. If you don’t do it or your loss is too high, the trade will close automatically. In fact, this is a good precaution. You may lose the margin and trading account, but at least you are not in debt.

This is also a means of protection for the opposite party. The foreign exchange market is built on the demand and supply principle (by which one side is selling while the opposite one is buying). If you don’t set your stop loss right and your trading account enables falling into red numbers it is likely that after a poor trade you will end up as a debtor! This is a disadvantage of Forex trading against binary options. We have talked about it in the previous article. With binary options, this can never happen.

What is stop loss and take profit?

You must have read, that when trading on Forex markets, losses and profits are unlimited, which is frequently stressed at our website. It is more or less true, which is why every serious  trader in this business uses  stop loss and take profit. These are price limits at which a trade will close automatically either in profit (take profit) or in loss (stop loss).

Traders enter the stop loss and take profit orders usually when opening a trade or soon afterwards. The limits should be derived from the trading plan. Once entering the market, you immediately know what you may expect: what profit you might achieve or what loss you are will be able to tolerate. This type of information is available. So why shouldn’t you use it! Once entered, the stop loss and take profit will display on the broker’s screen. Even if you switch off your PC, these levels will remain active. So, you don’t have to fear of your money.

There are loads of terms used by traders in the Forex market. For instance, pip which is the minimum price movement of a given instrument (currency). A lot of these terms are in English. I am sure that you will easily absorb more of the trader’s jargon. However, if you have some questions do not hesitate to ask us in the comments section below.

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Step

More about the author: Step

I've wanted to build a business of some kind and earn money since I was in middle school. I wasn't very successful though until my senior year in highschool, when I finally started to think about doing online business. Nowadays I profitably trade binary options full-time and thus gladly share my experiences with you. More posts by this author

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