Forex: The present mechanism of currency has gone through thousands of years trading, valuation of goods & services and payment evolution process. It started with barter system where goods and services were exchanged for each other. The inherent problems of the barter system required development of a common medium of exchange that can determine value of goods and services. This led to innovation of money, gold and silver coins were used and further innovation led to present system of paper currency. When money was branded by respective central banks it is called currency. In cross border trade (foreign trade) there was need to value one currency with other. This relative valuation of two currencies is called foreign exchange or forex (FX). Foreign exchange rate is represented through the two currencies in reference e.g. GBP/USD, EUR/USD, USD/CHF.
Derivatives: Derivatives are financial contracts that derive it's value from the underlying assets called forward, futures, options, swaps, caps, floors, CDS (Credit Default Swaps).
Forward Contract: is a non-standardized or customized or flexible derivative contract between two parties to buy or to sell an asset at a future time at a price agreed upon today. Non-standardization makes a forward contract flexible and customizable between the two parties. This customization is usually possible in case of bilateral trades between two parties but when the same contract is offered to a large number of potential traders, some amount of standardization is required.
Futures Contracts: An exchange traded forward contracts are futures contract, they are highly standarised. Time, place, quality, quantity, expiration, settlement and delivery of contracts are predefined and standardized.
CFD: A CFD (Contract for Difference) contract, is a forward (futures, if traded on the exchange) contract, a legally binding contract that obligates the two parties involved to trade, a particular amount/quantity (know as lot size) of the underlying asset at a predetermined price (contracted/traded price) to be valued on a predetermined future date referred as expiration date. Expiration date and settlement date may differ. Settlement date follows the expiration date usually by fixed number of business day(s). Lot size, Expiration and Settlement date may differ from system to system (market to market). CFD contracts are usually cash settled that does not result in delivery of the long/short underlying asset. If a seller does not prematurely close out the position, he or she may assume the risk that the value of the underlying asset will be cheaper some time before the expiration date. CFDs are OTC in nature.
Underlying Assets: In a derivative contract underlying assets could be a tangible or intangible financial instrument/asset or group of financial instruments/assets like currency pair. shares, bonds, warrants, indices weather forecast, electricity , a commodity or another derivative contract like futures (options of futures).
Lot Size: Lot size is also known as contract size can be defined as minimum amount/quantity of a financial/commodity instrument that can be traded (bought or sold). For example, if in a trading system minimum quantity of 100 troy ounces of Gold can be traded that means the size of one trade has to be at least of 100 troy ounces of Gold. A customer can either trade 100 troy ounces or multiple of 100 troy ounces. Therefore in this system 1 lot of Gold is equivalent to 100 troy ounces.
Expiration: Expiration refers to expiration date of a derivative contract that is the last date on which a derivative contract (forward, future, option etc) expires. Usually expiration of a contract is followed with the introduction of a new contract. New contracts are either introduced few days prior to the expiration of similar contract or the next business day after expiration. New CFD contracts are usually introduced few days prior the expiration of existing contracts. There are derivatives contracts which on expiration are cash settled and others through a delivery of the underlying asset.
Settlement Date: Settlement date is the day on which closed out positions or expired positions (are those open buy or sale positions in which tenure of a security, financial instrument or derivatives contract has expired) are settled either through cash (cash settled contracts) or delivery (deliverable contracts). In simple words date on or before which the funds or underlying assets or both must exchange hands between buyer and seller. Settlement date is usually after a fixed number of business days post close out date or expiration date.
Cash Settled Contract: A cash settled contract is a contract in which traders (buyer and sellers) agree to exchange differential value of their trades in the acceptable currency. CFD is a cash settled contract. For example a buyer/seller agrees to pay/receive the difference between contracted/traded price of the underlying asset of a cash settled contract and value of the underlying asset on the expiration.
Margin: A margin is cash/collateral that the buyer/seller of a financial instrument or a derivative contract has to deposit to cover some or all of the credit risk of their counterparty. It is also called performance bond. Margin acts as a good faith deposit to secure clients' financial obligations and the notional value of his position. There are two types of margin Initial Margin and Maintenance Margin.
Initial margin: is expressed either as a fixed amount or percentage of total value of a contract or financial instrument. A client needs to deposit initial margin or have credit balance of equivalent amount in his trading account before he/she can initiate (buy or sale) a position in a particular contract or financial instrument.
Maintenance margin: Usually less than the initial margin, is the minimum margin (amount), required to continue or maintain an open buy or sale position.
Usable Margin: The difference between initial and maintenance margin is called usable margin. Margin trading allows clients to hold a position much larger than the actual account value because of leverage. Margin calls are triggered when clients' usable margin reaches zero.
Leverage/Gearing: Leverage refers to a financial technique through which one can control much larger value of the underlying asset by using a relatively small portion of the collateral, in cash or acceptable (predefined) asset. Leverage is a double edge sword that can multiply gains or losses of a trader. Leverage is also referred as gearing. Example, a commodity trader deposits USD 5000 (5% of the total value of the asset) as margin (performance guarantee to take care of the fluctuation in the Copper prices) to buy a Copper contract valued at USD 100,000 @ USD 4000 per ton. Therefore we can say that the trader is having a leverage of 20 (USD 100000/ USD 5000) times. Wherein the same trader could actually buy (own) only 1.25 (USD 5000/ USD 4000) tons of Copper instead of now holding 25 (USD 100000/ USD 4000) tons of Copper.
Collateral: In leverage (margin based) market a trader (buyer or seller) of a financial instrument or derivative contract has to deposit a fixed amount or percentage of margin as collateral to take care of all or some of the credit risk of his counter party. The collateral could be cash or cash equivalent. Such collateral is not the part payment towards the ownership of the underlying asset; instead it is a deposit towards performance guarantee of his financial obligations that may arise from perceivable risk of future price volatility that market poses.
Volatility: Volatility refers to price variation or price fluctuation in a financial instrument, derivative contract or market. Volatility is the statistical measure of the price variation of a financial instrument over a given period. Larger the price variation higher is the volatility. Volatility does not establish direction of the price movement or trend. It is one of the most important factors to study the market behavior. It refers to uncertainties and risks. There are many factors that contribute to price volatility in a financial instrument,
Investors: Investors are usually long term traders. They acquire a security and hold it for longer duration. It is perceived that investors make more informed trading decisions and are less risk taking class.
Speculators: Speculators trade with high risk in expectation of high profit from the trade in relatively short term. Speculators provide liquidity and they also assume risks that the hedgers avoid by taking the counter trades.
Arbitrageurs: Arbitrageurs take advantage of the price discrepancies between two financial instruments having correlation or two similar derivatives contracts having different expiration or similar derivatives contracts traded in two different markets. They are risk neutral. Arbitrageurs bridge the gap of price anomalies between two financial instruments.
Hedgers: Hedgers are risk averse and they take position in the market for risk mitigation. They buy or sale a particular commodity or financial derivative contract to offset potential loss that may occur in future due to price fluctuation in the underlying asset.
Discretionary Trading / Trading Authorisation: Discretionary trading allows an individual or an entity to trade on behalf of the account holders usually for a fee. Account holder signs an agreement / or issues a consent letter to trader authorizing him/her to trade on his behalf. Account holder is solely responsible for trading profits or losses.
Base and Quote Currency: In USD/JPY contract the base currency is USD and JPY is the quote currency. Therefore in a currency pair the first currency is referred as base currency and the second currency as quote currency. It is always expressed as how much a quote currency is needed to buy or sell a base currency. Quote currency is also known as counter currency and base currency as transaction currency.
Base Currency: Base currency is the domestic currency. For example if UK entity wants to trade in CME contracts and the acceptable currency for the margin is USD then the GBP will be converted to the USD at a prevailing exchange rate and when the entity wants to withdraw liquid cash from his account then the USD will be converted back to the base currency i.e. GBP
Pip: A Pip is the smallest change in an exchange rate of a currency. Major currency pairs are expressed till four decimal points. For Example, in GBP/USD exchange rate if the exchange rate fluctuates from 1.6423 to 1.6428 means there is a change of 5 pips (.0005).
Basis Point: Usually basis point is used to express a change in the interest rate. One basis point is equivalent to 0.01% therefore a change of 25 basis points in interest rate means .25% (quarter of a percent) change in interest rate.
Bear and Bull: Bear reflects down trend in the price movement of a financial instrument or market. Opposite of bear is bull. Therefore bull represents upward movement in the market. Bear and bull are also expressed as southward and northward trends respectively.
Bid and Ask (Offer): Bid is purchase offer or offer to buy and ask also expressed as offer is an offer to sale a financial instrument or derivatives contract. A bid price is usually less than ask (offer) price
Spread or Bid-Ask Spread: The difference between the best offer and best bid price is called bid-ask spread.
Cable: Cable is the term used to describe GBP/USD currency pair. The term is more than century old the exchange rate between two currencies were transmitted through large cable.
Clearing Corporation or Clearing House: A clearing corporation or house assumes counter party risk, they act as counter party to each trade. A clearing house generally provides centralized clearing, risk management, information and settlement services.
Chartist: A chartist is also known as technical analyst; he studies the traded historical prices of a financial instrument to establish a trend with the help of various technical analysis tools like indicators and other charting tools to establish trends in the market. They do not consider fundamental changes while establishing a trend in the market movement.
Contract Note: Contract note is confirmation of a trade. A broker normally sends such confirmations that carry information like, price, time, date, value, commission/brokerage of trade. Also contains client information such as name, account no.
Majors and Crosses: Majors are the currency pairs that involve USD either as base or quote currency. Major currency pairs are EUR/USD, GBP/USD, USD/JPY, USD/CHF, AUD/USD, NZD/USD and queens currencies. Crosses refer to currency pairs that do not involve USD, example CAD/CHF.
Contango or Backwardation: Theoretically future/forward price should always be trading at more than Forex price. This means that the cost of carry is positive. In Contango, future/forward price trades above the Forex price whereas backwardation refers to a scenario where the future/forward trades below the Forex price. Contango is also referred as normal market and backwardation as abnormal or inverted. The difference in Forex price and future/forward price is called basis. If the basis is negative (Forex – future/forward) is normal and therefore in contango and positive basis is backwardation or inverted. In real world we often see future/forward prices in backwardation.
GAP: Gap or gapping happens when the there is sharp movement in the market. When market moves in a particular direction without trading at all levels, it creates gap. It happens in most of the market and least in the currency market. However this is seen in certain cases, specifically during the major economic data releases, major political shift or announcements and also at the start of new trading session.
Fair Value: Fair value explains the relationship between the Forex price of an asset and futures/forward price of a contract (same underlying asset). Fair value is the theoretical value of a future/forward contract. Fair value of future/forward contracts may vary depending upon the underlying assets. Factors such as dividend, expiration date, interest rates, cost of holding and yield are some of the factors relevant to different asset classes. In other words, in the futures/forward market, fair value is the equilibrium price for a futures/forward contract. In real world futures/forward contracts may not necessarily trade at fair price and therefore discrepancies may occur and this would attract arbitrageurs to participate in the market.
Index: In simple words an index indicates or reveals or guides, in economics and finance an index is a statistical measure of change in a group. Different indices are calculated differently. It represents a group and indicates the overall change in the group but not in each and every component of the group. There are various types of indices, some of them are, Economic index – for example Whole Sale Price index that represent the change in the price of goods that are sold in bulk and traded between organizations instead of consumers. WPI is used as a measure of inflation in some economies. Similarly you have Consumer Price Index Stock Market Index – it measures the change in a group of stocks listed on a particular stock exchange such as S&P 500, Dow Jones Industrial Average, Nifty. Not all these indices are calculated based on same principles and methodology. S&P 500 is market capitalization weighted where as DJIA is price weighted. Commodity Indices – Thomson Reuters Equal Weight Continuous Commodity Index (CCI), Thomson Reuters/Core Commodity CRB Index (TR/CC - CRB Index), Goldman Sachs Commodity.
Indicators: Indicators are statistical tools to measure current economic and financial conditions and trends as well as to forecast future trends. There are economic indicators and technical indicators, Economic indicators – e.g. employment, poverty, GDP, inflation rate etc. Technical Indicators – these indicators are used in price trend analysis of financial instruments or commodity prices. There are hundreds of such indicators such as Moving Average, Rate of Change (ROC), Relative Strength Index (RSI), Moving Average Convergence Divergence (MACD) etc.
Inflation: Inflation is continuous increase in general level of prices of goods and services. It is measured as percentage increase in same goods and services over the last year. Upward change in Whole Sale Price Index and Consumer Prices Index are the indicators of inflation. Generally interest rates are increased to control the money supply and therefore inflation.
Last Trading Day: Last trading day sometimes refers to expiration day or the day when a particular forward/futures contract expires specifically in cash settled contracts. However in case of a futures contract last trading day refers to a day beyond which holders of a contract are liable to either take or give delivery of the underlying asset.
Liquidity: Liquidity refers to a market condition in which large number of trades can be executed with ease on a single price level.
Long/Short: Long position refers to buy position and short position as sell position.
Portfolio: Portfolio refers to combination of different assets held by an individual or an entity.
Partial Fill: Partial fill refers to only a part of the total order executed. That means complete order has not been executed due to market condition or for any other reason.
Quote: Quote refers to a price of a stock, commodity, bond etc. Bid quote refers to the current price at which a buyer is ready to buy, ask (offer) quote refers to the current price at which a seller is ready to sell.
Support and Resistance: These are important technical levels often referred in technical charts and analysis. They are psychological barriers in reference to a financial instrument. Therefore a lot of buying and price of the financial instrument in reference would bounce back. They are pivotal levels where the demand and supply meet.
Rollover: A currency rollover is the process through which all open positions are rolled over to the next business day and therefore extending the settlement date. In this process a trader continues to hold his Forex position by paying/receiving currency swap rates.
Tick Size: is the smallest change through which price of a financial instrument and derivatives contract is allowed to move. Tick size is the part of contract specification and is usually defined.
Time to Maturity: In a derivatives contract time to maturity refers to remaining number of days before expiration or remaining life of a contract after which it ceases to exist.
Value Date: It refers to a day when price of a fluctuating financial instrument or derivatives contract is determined.