What is forex trading and how does it work? - Beginner's guide
Forex (FX), or currency trading, is a worldwide market in which global currencies are traded. The FX market is the world's biggest and most liquid, with $5 trillion in average daily trading volume.
The combined stock markets of the globe are nothing near this. If you look closely into Forex trading, you will discover some fast-paced trading opportunities that are not accessible with other speculative instruments.
In this article
Key Takeaways
- The foreign exchange (Forex or FX) market is a worldwide marketplace where global currencies are exchanged.
- Because of the global scope of trade, business, and finance, FX markets are the world's biggest and most liquid financial markets.
- Currencies are traded in pairs. The EUR/USD, for example, is a currency pair where the Euro trades against the US dollar.
- Forex markets operate as spot (cash) and derivatives, with forwards, futures, options, and currency swaps available.
- Market players use Forex to hedge their international currency exposure and interest rate risk. And also to speculate on geopolitical events, and diversify portfolios.
What is forex trading?
Forex, or foreign exchange, may be defined as a network of buyers and sellers who exchange currencies at agreed prices. It is the process through which people, businesses, and central banks exchange one currency for another.
While some foreign exchange is done for practical reasons, much is done for pure speculation. Because of the volume of money exchanged each day, the price swings in certain currency pairs may be quite erratic. This volatility is what makes Forex so appealing to traders: it increases the possibility of large winnings within a high-risk trading environment.
Forex market is open 24 hours a day, 5 days a week.
Traders can buy and sell currency pairs like GBP/USD (British pound against the US dollar) and thereby speculate on their price movements. The difference between the opening and closing prices determines whether the trade makes a profit or a loss.
Not sure why you should trade forex? Click here.
Foreign exchange market
The FX market operates 24 hours a day, from Monday to Friday, and is not located in a central location or exchange. A broad variety of currencies are regularly exchanged as people, businesses, and financial organisations conduct worldwide commerce and try to profit from rate swings.
Corporations that have done business with corporations in other countries must use the foreign currency market to transfer payments for imports, exports, or services.
However, retail traders account for a substantially smaller number of currency trades. Retail traders seek to benefit from price fluctuations in different currencies by using both technical and fundamental research. While they make up a smaller percentage of overall forex participants, retail traders certainly help to raise trading volumes and boost overall liquidity.
How does forex trading work?
One distinguishing feature of this international forex market is the absence of a central marketplace for trading. Instead, currency trading is done electronically over the counter (OTC), with all trades taking place over computer networks between traders all over the globe rather than on a single controlled exchange.
The market is open 24 hours a day, five days a week, and currencies are traded in practically every time zone in the main financial capitals. This means that when the trading day in the United States finishes, the currency market in Asia starts afresh. As a result, the currency market may be quite busy at any moment, with price quotations changing regularly.
Learn more about base and quote currency and how forex is traded in pairs.
Leverage in forex trading?
Leverage enables Forex traders to obtain greater exposure with less of their own money while trading. Forex usually offers higher leverage than other financial products, which means traders can get exposure to currency trading with a relatively small investment.
One of the reasons why many individuals are interested in trading currencies via spread betting, or CFD trading account, is the availability of leverage. However, you should be aware of leverage's potential risks, as it is a double-edged sword.
Spreads in forex trading
In Forex trading, the spread is the difference between a currency pair's buying and selling price. When trading forex pairs, the 'ask' price (where you buy) is always higher than the 'bid' price (where you can sell). This price difference is known as the 'bid-ask' spread. We offer both fixed and variable spreads. There are variable spreads on CFDs which are traded on our MT4 platform, while fixed spreads are available on our proprietary platform where we offer spread trades/bets.
Variable spreads:
These can change at any time and will often widen significantly if the underlying market gets volatile. Large price swings are quite common in Forex. And when this occurs, the spread will likely widen, and your trading costs will suddenly go up.
Fixed spreads:
These stay exactly the same, no matter what's happening in the underlying forex market. With fixed spreads, traders have complete transparency over their costs. Our fixed spreads tend to be lower than our competitors. But most importantly, they don't widen just because market volatility picks up.
This way, you can be certain that your spread will stay the same even if those in the underlying Forex market don't. You can see all our fixed spreads in our market information sheet.
What are the main ways to trade forex?
The two most popular ways to trade Forex are spread trading and CFD trading.
With spread trading, all your trades are made in your preferred currency. If your spread trade account is set up in euros, then all your profits and losses will be in euros. This is different from CFDs, where your profits and losses may be in an unfamiliar currency, depending on which Forex pair you trade, which you'll need to convert to your preferred one at additional expense.
Spread trading also lets you choose how much you want to trade per point, whereas you have less control when using CFDs.
Forex trading strategies
Forex traders use FX trading strategies to drive their trading decisions. Trading is distinguished from guessing by the capacity to follow a strategy that guides a trader's decisions.
A currency trading strategy will often comprise technical analysis (a variety of signals and indicators) and fundamental analysis. A Forex trading signal may assist in choosing entries and exits in a specific currency market.
Most Forex trading strategies include analysing chart patterns to identify buying and selling opportunities. Algorithms are also used in automated systems to generate trading signals and trade depending on many pre-set parameters.
Many traders incorporate scalping to open and close a trade as soon as possible to make tiny but frequent gains. In contrast, others may use swing trading strategies to hold trades for days, if not weeks.
Other traders will make trading decisions based on macroeconomic news. This 'big picture' news often impacts FX markets more than any other aspect, at least over the short term.
Is forex trading right for you?
Forex trading is popular with all levels of traders as the market is closely tied to world events, making it exciting and fast-paced. You also don't need much money to get involved. Forex is traded on margin. Essentially your broker lends you the majority of the funds required to open a forex trade. This means you are employing leverage which magnifies both your profits and losses.
One of the biggest questions asked by most traders is if they can make money trading forex.
All leveraged trading involves risk. As your profits and losses are magnified when compared to your margin, it's vitally important that you carry out strict risk and money management ahead of placing any trades and only put up money you can afford to lose.
When you trade Forex via spread trading (as opposed to CFDs), you can do so in the currency of your choice and choose exactly how much to stake per point, giving you total control over the amount you're trading.
What influences the forex market?
Trading the Forex market without an understanding of the elements that impact it can result in significant losses. Many of the macroeconomic dynamics may have a significant impact on a currency's value.
Here are the major factors that influence the Forex market:
Political and economic unrest
Political instability and bad economic performance, along with key elections and recession fears, can impact currency value. Politically stable nations with steady and predictable economic performance are typically more desirable to international investors. As a result, these countries attract investment away from countries with more economic or political unrest. This tends to have a positive effect on their currencies.
Interest rates
In order to manage inflation, central banks regulate interest rates. If a central bank wishes to reduce inflation, it might raise interest rates to discourage spending and lending. This can raise the value of their currency relative to others as a higher interest rate makes it more attractive to outside investors, all other things being equal. Currency swings are one of the reasons why Forex traders speculate on interest rate announcements from central banks such as the US Federal Reserve or the Bank of England.
Terms of trade
A country's trade terms indicate the ratio of export prices to import prices. When a country's export prices increase, and import prices decrease, the country's trade conditions improve. This improves the country's income, which leads to a rise in demand for the country's currency. This increase in demand may cause the currency's value to rise.
Foreign debts
A country's debt may have a significant impact on currency price fluctuations. Countries with high debt levels in comparison to their GDP can be less appealing to overseas investors. Countries that do not get foreign investments may struggle to increase their foreign capital, resulting in greater rates of inflation and currency devaluation, particularly if the country is unable to raise interest rates to compensate.
Potential risks of forex trading
Just like any form of trading, speculating or investing; risks are involved. Educating yourself on these risk factors will give you a better understanding and the opportunity to plan around them.
It is important to understand the following things while trading in Forex:
- Margin call - market volatility and fast price movements may cause the balance of your account to change rapidly. If you do not have enough money in your account to handle these scenarios, your trades may be closed automatically.
- Correlations: if you are trading a currency pair in which the interest rate change influences one currency. The effects of this change will be visible in correlated pairs as well. This is because Forex instruments can often correlate, either positively or negatively.
- Market volatility and gapping - prices in financial markets can change quickly, and potential gaps can occur due to market volatility. This is where prices may jump upward, or fall downward creating a gap, where there is no trade at the intermediate prices. Where this happens, usually after a weekend or holiday closure, stop-loss orders may be executed at unfavourable prices.
Is forex a trader's favourite?
Forex trading is a fast-paced and thrilling alternative to trading on individual stocks. Some traders will only trade this asset class. They may even opt to specialise in only a few specific currency pairs, devoting significant effort to comprehending the economic and political aspects that influence particular currencies. Therefore, we advise our traders to do proper due diligence before trading forex markets.
People also ask
What motivates people to trade currencies?
Businesses and dealers use Forex for two major reasons: speculation and hedging. Traders utilise the former to profit from the increase and fall of currency values, while the latter is used to lock in pricing for production and sales in foreign markets.
Is the forex market volatile?
The Forex market is one of the most liquid in the world. A currency's volatility is determined by various variables, including the country's politics and economy. Consequently, economic insecurity in the form of a payment failure, trade imbalance or geopolitical uncertainty may cause severe volatility.
Are forex markets regulated?
The jurisdiction governs Forex trading regulation. The Financial Conduct Authority (FCA) oversees and regulates Forex trading in the United Kingdom. The Australian Securities and Investments Commission (ASIC) oversees and regulates Forex trading in Australia. The Securities Commission of The Bahamas (SCB) regulates Forex trading in the Bahamas.
Countries such as the United States have advanced infrastructure and marketplaces for conducting currency trading. As a result, Forex trading is controlled by the National Futures Association (NFA) and the Commodity Futures Trading Commission (CFTC).
However, because of the high level of leverage utilised in Forex trading, emerging nations such as India and China impose limits on the businesses and money that may be used in Forex trading. Europe is the biggest FX trading market.
Is forex trading risky?
Like other leveraged products, Forex trading can be risky if you don’t know what you are doing. Therefore you should carry out strict risk and money management before opening any trade, and only speculate with money you can afford to lose.