CFD markets involve some important concepts that you need to understand before you can start trading. Some of the most crucial to know are spreads, pips and lots. Without understanding these, it would be very foolish for a person to trade with real money. You also need to understand other terms like margin and swap. While you can of course look at Exness Education’s glossary for short summary definitions of many terms, this practical glossary of trading focusses on the most important ones in greater detail.
What’s a spread?
A spread is the difference between the prices to buy and sell a symbol. It’s essentially the fee that Exness charges for providing its services. Spreads basically reflect the cost to Exness of employing people, running servers and platforms, developing new services and various other costs of running a broker.
Spreads work in practice by splitting the price of a symbol into two prices in the trading platform. These two prices are ‘ask’ and ‘bid’. A trader buys at the ask – which is always higher – and closes orders to buy at the bid. The opposite is true for selling, with sells opening at bid and closing at ask. This is why you always see a small loss as soon as you open a trade.
The spread is the difference between the red and grey lines on the chart. You can also notice the difference between bid and ask at the top left. Click on the image to magnify.
Exness’ spreads typically range from about 0.003% to 0.01% of the nominal value of a contract. Spreads depend on the specific symbol being traded, conditions such as news releases and the time of day. Some traders, especially those who focus on very short-term trading, aim to trade symbols with the lowest possible spreads.
Pips and points
Pips are essentially a measure of how far price moves, but they also measure spreads and a range of other things. In most cases, a pip is the fourth decimal place of a quotation:
GBP-USD BUY 1.27841 SELL 1.27829
Here the pip is the second last number of the prices quoted. The spread, then, is 1.2 pips.
Traders should note that the position of the pip varies depending on the symbol being traded. For example, metals and cryptocurrencies function differently from most forex pairs. Pairs with the yen are also different. The easiest way to acquaint yourself with pips and how they work is to use a combination of a demo account and Exness’ Trader’s Calculator.
Points are mainly a feature of MetaTrader 4 and MT5. A point is one tenth of a pip. If MT4 tells you that the spread for dollar-yen is 8 points, this means that the spread is 0.8 pips. It’s important to remember the difference between pips and points because many functions in the platform such as stops could be less effective if you confuse them.
Sizes of trades and leverage
The size of trades in CFDs is measured in lots. Usually a standard lot in forex is 100,000 units of the base currency. A mini lot or 0.1 lot is 10,000 units of the base and a micro lot or 0.01 lot is 1,000.
In most cases it’s possible for a trader to make an order from 0.01 to 20 lots assuming that they have enough money. They should of course remember that trading bigger lots means that any losses and profits will be bigger, other things being equal. In practice, almost all new traders start with 0.01 for every trade during at least the first few months.
Leverage as well as lot sizes affects traders’ ability to open new orders. Leverage allows traders to open larger orders than would otherwise be possible without leverage.
Leverage in practice
For example, a trader using leverage with a ratio of 1:30 can open orders up to 30 times the actual value of their available funds. If they wanted to open a micro lot of dollar-yen with this leverage, they’d only need $33.33 instead of $1,000.
Leverage is popularly known among traders as a ‘double-edged sword’. Contrary to popular belief, though, leverage in itself doesn’t make losses more likely. However, and crucially, it does increase the amount of any losses you make, other things being equal. Conversely, it also functions in practice to increase the gains made by experienced traders.
New traders should keep leverage as low as reasonably possible. There is no ‘best’ leverage for new traders. However, many experienced traders started with the European default for forex of 1:30. As above, an excellent way to explore how sizes affect performance is to test different sizes of trades on a demo account and analyse the results carefully.
Other key terms: margin and margin level
Margin is the amount of money required to sustain open trades. In derivatives, it depends on both the sizes of trades and leverage.
Taking the same example as above of dollar-yen, the margin without leverage is $1,000 for a micro lot. This means that a trader needs to have $1,000 (or equivalent in another currency) available in their account to open this trade and keep it open. With leverage of 1:30, they’d need $33.33 or equivalent in margin.
Free margin meanwhile is the amount of money in your account that’s not currently in use as margin for trading. In other words, it’s the amount that a trader could use to open new orders.
Margin level is a ratio of equity (balance plus or minus total running profit or loss) to margin as a percentage. It’s basically a measure of the health of your account. If it gets too low, you won’t be able to keep trading. For some types of account, you can continue trading until your margin level reaches 0%. For other accounts, you’ll be stopped out from trading at a margin level of 50%.
The key terms in the platform
The grey and white area at the bottom of the window of MT4 is the terminal. MT5’s equivalent is the toolbox. This area shows the balance, equity, margin, free margin and margin level of the account. It’s extremely important to look at this line regularly. Click on the image to magnify.
The easiest way to understand how these terms affect trading in practice is to try trading on a demo account. Instead of manually calculating things yourself, the combination of Exness’ Trader’s Calculator and a demo account can teach you how the key figures work much more effectively. If you’re confused about a particular term, Exness Education’s glossary gives handy summary definitions in addition to the longer explanations in this glossary of trading.
The practical glossary of trading: swaps and carries
Swaps are the final key term that you need to know. A swap is essentially a fee for keeping a position open overnight. Sometimes you pay this to your broker, a ‘swap’, and other times your broker pays it to you, usually called a ‘carry’.
The main basis of overnight charges is different interest between currencies. For symbols other than forex, they reflect other but comparable overnight costs. For example, if a trader wants to buy euro-dollar and hold their position overnight, this costs money in swap. If they sold instead, their order would come with a carry. This is primarily because there is a difference in base rates between the euro and the dollar.
In practice, swaps rarely reflect differences in rates exactly. This is because a range of other factors also affects the calculation, such as liquidity available, demand, measures by central banks apart from rates and a range of others. Swaps are the standard rate every weeknight except usually Wednesdays. Triple rate applies on Wednesdays for most instruments to represent the costs over the weekend when markets are closed. For some instruments like crude oil and indices, Friday is the day of triple swap.
Most symbols have particular values for swaps which change from time to time. You can find these in their properties in MT4 and MT5 and on the page on contract specifications on Exness’ website. Instead of you calculating potential swaps before trading, Exness’ Trader’s Calculator can do this for you.
Does Exness want to make money from clients’ losses?
No. Approximately 90% of Exness’ profits come from spreads. The remainder comes mostly from other costs to trade, mainly swaps, but also commissions from Zero Spread accounts.
Transparency is one of Exness’ core values on which our success relies. We firmly believe that acting in the best interests of our clients is also in our best interests as a business.
This is one of the reasons why we were among the first brokers to publish audited financial data. You can check Exness’ financial audits on our website to confirm that our clients collectively withdraw an average total of around $30,000,000 every month. We have no wish for our clients to lose money in trading because we make money from spreads.
Well done and thank you for reading the practical glossary of trading! If you’ve read all of the articles in Exness Academy’s essentials, you should consider moving on to managing risk to continue building your knowledge.
Test your knowledge by trying this short quiz.
0 of 4 questions completed
You have already completed the quiz before. Hence you can not start it again.
Quiz is loading…
You must sign in or sign up to start the quiz.
You must first complete the following:
0 of 4 questions answered correctly
Time has elapsed
You have reached 0 of 0 point(s), (0)
Earned Point(s): 0 of 0, (0)
0 Essay(s) Pending (Possible Point(s): 0)
Where is the usual place of a pip in most forex pairs?CorrectIncorrect
What’s the most important practical result of using leverage?CorrectIncorrect
The bid price is always higher than the ask price.CorrectIncorrect
How does Exness mostly make money?CorrectIncorrect