An order execution at the market may seem simple; in fact, you can limit yourself to just selecting between to buy or sell. However, some decisions are associated with the entry of an order into the market. These decisions are: What will be the cost of entering the position? When to open the trade? What size will be right? How much margin will be required?
Bid and Ask Prices
The Ask price is the price the market is willing to sell a particular asset. Usually, the trader will find it on the right side of under the term “Buy”. The Bid price, on the other hand, is the price at which the market is willing to buy a certain instrument. It can be found on the button on the left side under the term “Sell”.
The following is the whole Chart of the EUR/USD, extracted from the Metatrader 5 platform with its trade window located at the top left side and ask(red) and bid(grey) lines.
Pip is a short name for point in percentage and formerly was the smallest unit of the price variation of a currency, nowadays we can observe price movements beyond the pip decimal. Usually, for all pairs, except for those that include the Japanese Yen (JPY) the pip is the fourth decimal place, that is 0.0001 multiplied by 10,000. For those currencies that contain the JPY, a pip is their second decimal place, that is 0.01 multiplied by 100. Taking this measure into account, the trader can determine the spread and, also the number of pip units of profit and loss for a given trade.
Let’s see a couple of examples:
On The EUR/USD the pip distance from 1.12153 to 1.12870 is: (1.12870-1.12153) * 10,000 = 71.7 pips.
The USD/JPY pip variation from 111,210 to 111,695 is: (111.695-111.210) * 100 = 48.5 pips.
The Spread Concept
Retail brokers usually offer two kinds of trader accounts: STP and ECN.
ECN(Electronic Communication Network) are professional accounts which connect directly to the real market.
STP (Straight Through Processing) accounts don’t see the real market directly, but a local version of it. So the broker is the other side of the trade, who uses the liquidity of the real market to deliver the trades to his clients.
The Spread is the difference between the bid and the ask prices seen at the trader’s platform. On STP accounts, the spread is the amount the broker charges for the execution of an order. The spread varies from broker to broker. Also, the liquidity conditions of each instrument change the spread size. For example, the spread of a major pair like the EURUSD is not the same as a minor cross as the AUDNZD or an exotic cross like the EURHKD. In Figure 3, we show the different spreads for those three assets.
Before discussing the types of orders, we must understand that the trader has two types of order execution at his disposition: Market Order and Pending Order. We can observe it in figure 4 (right window).
On the one hand, Market orders are those in which the trader decides to place a buy or sell order at the instantaneous price currently quoted by the market.
On the other hand, there are two kinds of Pending orders: stop order and limit order. These orders are detailed below:
Buy Limit Order
The trader wants to buy at a lower price than is currently available.
Buy Stop Order
The order is intended to be executed at a price higher than the current market price.
Sell Limit Order
The trader seeks to sell at a higher price than the current one.
Sell Stop Order
The objective is to sell at a price lower than the current price.
The next decision that comes after the question Where to enter to the market? is How much will be the size of my position? To answer this question, we must introduce the concept of the Lot. A standard lot equals 100,000 units of the base currency. For example, one lot of the EUR / USD pair equals 100,000 EUR. One-tenth of a lot is called a mini lot, and one 1% of a lot is a micro lot.
A summary of what was discussed above is shown in the following table:
Leverage and Margin
Leverage is a ratio between the actual value of a transaction and the required amount to execute it. The most common rate is 100: 1, this means that with 1 USD you can control 100 USD of currency or another financial instrument.
The margin represents the amount of money the broker demands to cover the buy (or sell) of an individual financial instrument traded. The following table shows different levels of traded amounts: