Determining Position Size

An essential point to be noted before any trading program is started is that an assessment of the maximum amount of loss that is likely to occur needs to be carried out.

Any trader should have a sense of this maximum loss per lot, and then determine the amount he wishes to trade for a given account size that will yield tolerable drawdown.

Here are some terms you should familiarize yourself with if you want to go into online fx trading.

Ask: "Ask" is the price that the broker/dealer is willing to sell the underlying instrument for. It is almost the same thing as “offer”.

Bid: This is the price that the dealer/broker is agreeable with in terms of buying.

Bid/Ask Spread (or "Spread"): This is the distance between the Bid price and the ask price. It is usually in pips. The tighter the spread, the better it is for the trader.

Cost of Carry (also "Premium" or "Interest"): The cost of carry is the cost of holding a position open. It is quoted in dollars or pips per day.

Currency Futures: A typical example of this is the Chicago Mercantile Exchange or CME. Currency Futures usually refer to future contracts to be traded in the exchange market.

Drawdown: This refers to the intensity of a decline in the account value. It is measured from the peak of the wave to a particular trough and is calculated in terms of percentage or dollars. For instance, say a traders account value has increased from $10,000 to $20,000. Then it declines to $15,000 and then sees a subsequent increase to $25,000. The drawdown for the trader in this case would be around $5000. This is the drawdown that happens when the account suffered a decline from $20,000 to $15000. This occurs despite the fact that the account of the trader never incurred a loss from the time it was incepted. EBS: "Electronic Brokerage System", the electronic system on which major banks trade with each other. This is considered to be the most definitive indicator of prices at which currencies are "really" trading, at least for EUR/USD and USD/JPY.

Forex: Short for "Foreign Exchange". Refers generally to the Foreign Exchange trading industry and/or to the currencies themselves.

Fundamental Analysis: Strategic assessments or macro assessments of where exactly a currency needs to be traded should necessarily be based on any criteria other than the price action. The basic criteria currently involved are the economic situations of the country the currency represents, certain fundamental elements and last but not the least, monetary policy.

Leverage: Leverage occurs when the amount by which the traded notional amount exceeds the margin necessary to carry out a trade. It is expressed in most cases as a multiple.

Limit: When an order that needs to be bought at a specific rate when the market declines towards that price or sold at a specific rate when the market rises to that rate is known as limit.

Liquidity: This is a function of activity or volume in a market. It is basically the cost effectiveness and efficiency with which trading and executions of positions take place. A market that is more liquid provides frequent quotes of cost at a lesser ask/bid spread.

Margin: In order to open a position or in order to maintain a position that is open, the client requires a certain amount of funds. This is referred to as a margin. For instance, a 2% margin means that $2000 of the deposit funds is necessary for a $200,000 position.

Margin Call: This is the amount of funds in excess that is required by a broker to maintain his open position. In certain cases a margin call can also indicate that the position that has insufficient funds will be closed out by the broker. By means of this procedure, the client can avoid losses.

Market Order: This is an order to buy the instrument at the ask price that is current.

Offer: This is the price at which the dealer is willing to sell. It is the same as “Ask”

Pip: Pip is the smallest of the small increment in price in a currency. In future markets it is referred to as “ticks”.

Roll over: When futures expire, they are changed to a new contract. This is known as a roll over.

Spot Foreign Exchange: This is also known as interbank market. The spot foreign exchange is the currency that is traded between two counterparties mostly banks. It is generally traded on margin basis.