Forex Terminology, Products, and Market Concepts
How a retail forex trade works
Off-exchange retail forex is a contract between a customer and a registered dealer to exchange one currency for another. In a pair, the base currency comes first and is always one unit; the quote (counter) currency comes second and states the price. EUR/USD 1.1050 means one euro buys 1.1050 dollars. Buying is going long the base currency; selling is going short the base. Because every trade has two legs, a long EUR/USD is simultaneously a short USD position.
Pips, lots, and leverage
A pip is 0.0001 for most pairs and 0.01 for yen-quoted pairs. A standard lot is 100,000 units of the base currency; mini is 10,000; micro is 1,000. Leverage is the ratio of position notional to the security deposit. In the United States that deposit is set by rule at 2% of notional for major currencies (50:1) and 5% (20:1) for non-majors, so maximum leverage is a regulatory limit, not a marketing choice.
Products and market concepts
Retail forex is OTC and bilateral: the dealer is the counterparty, and the dealer earns mainly from the bid/ask spread. Positions held past the daily settlement cutoff are rolled over, producing a debit or credit based on the interest-rate differential plus the dealer's markup (the carry trade). Distinguish spot forex from FX futures, which trade on exchanges such as the CME, carry a performance bond rather than a 2% security deposit, and are not the subject of this exam.
Worked example. You buy 1 standard lot of EUR/USD at 1.1050 and close at 1.1075. Pip value = 100,000 x 0.0001 = $10. Gain = 25 pips x $10 = $250. Required deposit = 2% x (100,000 x 1.1050) = $2,210.
Traps: reversing base and quote; computing pip value with the wrong currency when USD is the base; assuming a margin call when the dealer must actually liquidate; confusing exchange-traded futures with OTC retail forex.