| Updated: October 23, 2025Basic terms of Forex trading
This article will cover the following
- How currencies are traded in the market
- How movement in currency values is measured
- What a spread is and why it matters
- Bulls and Bears – what they are
- Positioning in the market
In this article, we outline the most important terms that are an integral part of the Forex trading world.
What are “currency pairs”?
When a beginner first encounters a currency-trading platform, he or she will notice that every national currency is traded in a pair with another. These are called currency pairs. Each pair comprises one base currency and one counter currency (quote currency).
If we take, for example, the GBP/USD pair, the United Kingdom’s pound (GBP) is the base currency, while the United States dollar, also known as the “greenback”, is the counter currency.
In Forex trading, as in stock and commodity trading, a single price is quoted for each currency pair. When trading currency pairs, a trader buys or sells the base currency against the counter currency. In our example, we are not simply buying the British pound; we are buying the pound with a specific amount of US dollars.
If the GBP/USD pair is trading at 1.6395, it means that 1.6395 units of the counter currency (USD) are required to buy one unit of the base currency (GBP).
If the US dollar strengthens, fewer US dollars will be needed to buy one British pound. Because the dollar is the counter currency in the pair, a stronger dollar causes the GBP/USD pair to fall. If it was previously trading at 1.6395, it might now trade at 1.6380, meaning fewer dollars are required to purchase one pound.
Another important point when trading currency pairs is that a trader does not need to hold US dollars to buy the GBP/USD pair. He or she may start with euros, which will be converted into US dollars and then used to buy British pounds.
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What is a pip?
In Forex trading, movement in the prices of currency pairs is measured in “pips”. A pip is an acronym for “percentage in point”. This is the smallest price change an exchange rate can make. Most major currency pairs are priced to four decimal places, so in this case the smallest change is that of the last decimal point – for most pairs this is the equivalent of 1/100 of 1%, or one basis point.
If GBP/USD is trading at 1.6370, the final digit (0) represents the pip. If the price rises to 1.6371, it has moved by one pip.
Forex traders usually measure their profits and losses in pips. If a trader buys GBP/USD at 1.6370 and the price rises to 1.6390, it has moved 20 pips, giving the trader a profit of 20 pips.
Some trading platforms quote prices to a fifth decimal place; this fraction of a pip is called a pipette. For example, GBP/USD may be displayed as 1.63708.
It is also worth noting that yen pairs are quoted differently: the pip is the second digit after the decimal point and the pipette is the third. If USD/JPY is quoted at 101.548, the number 4 is the pip and 8 is the pipette.
The importance of spreads
In Forex trading, the spread is the fee (commission) that a broker charges each time you open a trade. New traders often underestimate the importance of spreads, yet they are one of the key factors to consider when choosing a broker.
Example
Let us illustrate what a spread is. If the GBP/USD pair is quoted at 1.6350 and you wish to buy, your broker will not sell at 1.6350; you may be offered 1.6352 instead. Conversely, if you wish to sell, you might receive 1.6348 – the price at which the broker will buy from you.
As you can see, there is a 4-pip difference between the two quotes (1.6348 and 1.6352). This is the spread – the gap between the price at which the broker will buy from you and the price at which he will sell to you. Because the broker buys at a lower price and sells at a higher one, the spread represents the broker’s profit.
Many trading strategies rely heavily on tight spreads, and a wide spread can render a system unprofitable. If your strategy involves opening many positions over short time frames, it is highly advisable to use a broker that offers low spreads.
The spread varies for each currency pair. Highly liquid pairs typically have tighter spreads, whereas crosses with lower liquidity generally carry wider spreads. This is one of the main reasons many traders favour pairs such as EUR/USD; its relatively narrow spread makes it especially suitable for scalpers who enter many positions each day and require the lowest possible costs. We will examine scalping in more detail later.
Bid and Ask
The bid is the best available price at which a trader can sell an instrument at a given moment. In the Forex market, the bid price is the highest price the broker is willing to pay to buy the instrument from the trader.
The ask (or offer) is the best available price at which a trader can buy an instrument. In the Forex market, the ask price is the lowest price at which the broker is willing to sell the instrument to the trader.
Trading instruments (Assets)
By trading instruments, or assets, we refer to the items that are being traded at the moment. If we are trading gold, then gold is the trading instrument. If we are trading a currency pair (USD/CAD, for example), then the currency pair is the trading instrument.
Opening and closing a position. Entry and exit
When a trader buys or sells an instrument, he or she opens a position in the market – this is called entering the market. When the trader exits the market, the position is closed.
Opening a position, whether by buying or selling, is known as making an entry.
Closing a position to realise a profit or loss is called making an exit.
Stop loss and profit target
A stop-loss is an order used to exit the market when a trade moves against you. Imagine a trader who has opened a long position, but the price starts to move in the opposite direction. If the position remains open, the trader could lose most or all of the funds in the trading account.
A stop loss order actually prevents the trader from suffering heavy losses. The order will automatically close the position once a specific price is reached. We will examine the basic order types later.
Profit target refers to the price at which a trader plans to exit the market and secure the profit. It is usually set before entering the trade, so the trader knows in advance how much will be earned if the market moves as expected.
Bear market versus Bull market
One of the most important considerations when investing is whether prices are trending up or down. Sometimes, however, the market moves without a clear direction, or, as many people say, it ‘trades sideways’. Prices that fluctuate without a noticeable trend are difficult to predict and therefore hard to profit from, so beginners are advised to avoid trading during such periods.
When a clear trend emerges, the market can move in one of two directions – up or down – commonly referred to as a bull or bear market.
A bull market is any financial market in which prices are rising, or are expected to rise. The term comes from the way a bull attacks, thrusting its horns upward, whereas a bear swipes its paws downward.
Bull markets are characterised by strong investor confidence, optimism and the belief that the upward movement will continue. ‘Bullish’ investors, attracted by the momentum, buy assets in the expectation that prices will keep rising and can later be sold at a higher level.
Conversely, a ‘bear market’ describes a period during which prices, in general, are falling. Widespread pessimism becomes self-fulfilling: as investors fear further losses, they sell, which in turn drives prices even lower.
A “bearish” investor who wants to profit when prices are trending down will enter a short position, betting that prices will extend losses. Shorting, however, requires more skill to manage and isn’t suitable for inexperienced traders.
Types of Positions
There are two basic position types in the markets: long and short. Taking a long position means buying an instrument with the intention of selling it later, after its price has risen, and earning the difference. Other expressions for this are ‘trading the long side’, ‘being long’ or ‘going long’.
Taking a short position means you expect prices to fall and therefore sell. When shorting, you borrow, for example, shares from a broker and sell them on the market. Later, you must return what you borrowed by buying it back; if the price has fallen, you profit from the difference. In essence, you sell something you do not own at today’s higher price and later repurchase it at a lower price to repay the broker.
For example, an investor places an order to sell short 100 shares of XYZ Corp. at $25.00 per share. The order is executed immediately, and the investor receives $2,500 in cash.
Two weeks later, the price has fallen and the investor can buy back the shares (cover the short) at $20.00 each. He spends $2,000 to repurchase them. The profit is $500 ($2,500 received minus $2,000 paid). Put differently, he earned $5 per share, for a total gain of $500 ($5 × 100).
Short-selling of currencies differs from “shorting” stocks
Beginners should note that short selling a currency pair is different from shorting a stock. In a currency pair, one currency is always bought and the other sold. If you trade GBP/USD and go long, you are buying British pounds and selling (shorting) US dollars. If you go short GBP/USD, you are buying US dollars and selling (shorting) British pounds.
Risk/Reward ratio
New traders often want to dive straight into the market and open their first Forex position as quickly as possible. However, beyond knowing the basic terms and how to enter a trade, a beginner must also understand the risk-management aspect of any trading idea.
Proper risk management is essential to any trading plan; it allows the trader to know exactly where to exit if the price moves against them. That’s why we’ll focus on understanding the Risk/Reward ratio.
The Risk/Reward ratio compares the expected profit on a position with the amount that could be lost. Understanding this ratio helps traders manage risk by setting expectations before entering a trade. The key is to find a positive ratio for your strategy. In this way, the profit when you are right is greater than the loss when you are wrong.
Number one mistake
Understanding these ratios can help newcomers avoid the number-one mistake traders make. After reviewing more than 12 million trades, analysts found that although most trades were closed at a profit, overall losses still exceeded gains because traders risked more on losing positions than they gained on winners. In other words, most traders used a negative Risk/Reward ratio, which requires an unrealistically high win rate to offset the losses.
One way to avoid this scenario is to use a minimum Risk/Reward ratio of 1:2. This maximises profit on winning trades while limiting losses when a trade moves against you. For example, if a trader expects a trade to yield at least twice the amount risked, the ratio is 1:2. Many traders look for a ratio of at least 1:3 before entering a position in the trade.