What Is Forex Trading? The Essential Guide

 

Welcome to the exciting world of forex trading. Whether you’re a novice looking to explore the forex market for the first time or a seasoned veteran looking to sharpen up your knowledge and skills, you’ve no doubt got a lot of questions about this increasingly popular global trading platform – luckily, that’s where we come in!

This handy guide will act as a comprehensive overview of all aspects of currency trading, addressing all the ins and outs of the market to answer one fundamental question: what is forex trading?

How does forex trading work?

 

So, first things first: how does it all work? Though the complex charts, graphs and indicators can all seem a bit daunting, the fundamentals of the market are actually pretty simple.

Forex (also known as foreign exchange, currency trading or FX) is a global trading network of buyers and sellers – home to individuals, companies, financial institutes and central banks – trading with each other through the conversions of international currencies. In essence, if you’ve ever jetted off abroad and converted your currency, you’ve already partaken in a type of forex trading.

Traders make profit or loss on the market through the differing exchange rates of any given currency. While exchanging your GBP for Euros before your summer holiday serves a purely practical purpose, forex traders instead look to profit from these differing exchange rates – buying a currency at a certain price in the hopes they can later sell at an improved rate of exchange against an alternative currency.

This is achieved through trading in pairs. A trade is placed when a trader predicts one currency will strengthen or weaken against another, buying or selling accordingly in the hopes of profiting from the fluctuation in the exchange rate. For example, if a GBP/USD is valued at 1.31 (meaning £1 is equal to $1.31), a trader could buy a pairing in the hopes they could later sell at a higher valuation, when the GBP has strengthened against the USD. As a result, they would make a profit by receiving more money than they originally invested in this pairing.

 

How are these pairings traded?

 

Pairings can be traded on three different types of market:

  • A spot market – This is the physical exchange of a pairing at the precise moment a trade is settled
  • A forward market – This is where a contract is agreed upon in which a currency will be bought or sold at a specific price, with the trade being settled at a predetermined future date
  • A future market – This is where a legally binding contract is agreed upon in which a currency will be bought or sold at a specific price, with the trade being settled at a predetermined future dateSpot market is the most common trading platform amongst individual traders and brokers, with the major currencies being the most commonly traded units within each pair.

 

What are the major currencies in forex?

 

The 8 major currencies are:

  • US dollar (USD)
  • Great British pound (GBP)
  • Euro (EUR)
  • Japanese yen (JPY)
  • Canadian dollar (CAD)
  • Swiss franc (CHF)
  • New Zealand dollar (NZD)
  • Australian dollar (AUD)

 

These 8 popular currencies are the ones most frequently traded on the foreign exchange market, making up 80% of all global forex trades. All of these major pairings include the USD as either the base or quote currency.

What are base and quote currencies in forex?

 

Put simply, the base currency is the currency used as the foundation of a pairing’s valuation. For example, in the GBP/USD pairing, the GBP is the base currency and the valuation of the pairing will be determined by the USD’s worth against the GBP. Sticking with the same example, the USD would be the quote currency – the unit measured against the base currency.

To summarise, a currency pairing contains both a base and quote currency (you can find out even more about currency pairings by checking out our blog post here). These currencies are traded in lots of different sizes, known as pips.

What are pips in forex?

 

Most currencies are valued to a fourth decimal point, with a percentage in point (or pip) equating to the smallest measurement of a unit – the last decimal place of a quote. Trading in pips enables significantly smaller trades than trading in lots, minimising risk exposure.

What are lots in forex?

 

There are three types of lot that can be traded, usually by professional brokers and larger financial institutions. Because smaller independent traders can’t necessarily afford to trade in these larger units, most forex trading is subsequently leveraged:

  • Micro lots – equivalent to 1,000 units of your base currency
  • Mini lots – equivalent to 10,000 units of your base currency
  • Standard lots – equivalent to 100,000 units of your base currency

 

Forex charts

So, how is money made on the forex market?

 

Now you know more about what forex trading is, it’s time to take a closer look at how money is actually made on the forex market. We know that profit is made from fluctuations in exchange rates, but how are these valuation changes predicted and what is it that makes forex the most liquid trading market in the world?

 

What is spread in forex?

 

‘Spread’ refers to the difference in price between the buy and sell values of any given pair. Whenever a trader opens a position, they’ll be given the option to open a long or short position. Opening the former means you trade at the buy price (which is slightly above market price), whereas the latter entails trading at a sell price (slightly below market price).

This decision is determined by your predictions of how your base currency will perform against your quote currency. If you predict it will weaken, you go short – and vice versa – leveraging your trade accordingly.

 

What is leverage in forex?

 

Leverage enables a trader to gain exposure to large units of currency (the aforementioned ‘lots’) without having to pay the accompanying upfront cost. Instead, a trader is able to place a significantly smaller deposit (often in pips), known as a margin, with the profitability of the leveraged position being determined by the full size of the trade upon its close.

 

What is margin in forex?

 

A margin is the initial deposit placed by a trader to open a leveraged position. It’s often expressed as a percentage of the full position, with the required size of a margin varying based on the size of the full position.

 

What affects currency valuations?

 

Just like on any other financial market, currency valuations are primarily determined by supply and demand. There are, however, a range of contextual factors that play a part in the strengthening or weakening of a currency’s value:

  • Market sentiment – Market sentiment naturally plays a major role in determining a currency’s value. It only takes a few traders to believe a currency is heading in a particular direction (and open a position accordingly) for other traders to follow suit, increasing demand for a specific product and affecting its valuation as a result
  • Global affairs – Since the forex market deals with international currencies, current affairs ranging from natural disasters to geopolitical tensions can all have a major impact on the price of a product
  • Central banks – Supply of international currencies is, of course, controlled by the world’s central banks. As such, the implementation of new measures – such as quantitative easing – can have a major influence on a national economy and, in turn, the relative currencySo, in short, money is made on the forex market by opening a long or short position based on whether you predict a currency’s value will rise or fall against its pairing. Trades are often leveraged against full positions by marginalising your trade, with the profitability of a trade determined by the rise or fall in valuation of the full position – a fluctuation that can be influenced by a range of contextual factors.

 

Man monitoring the forex market on his smartphone

Can anyone trade forex?

 

It’d be a shame for you to have gotten this far only to learn the forex market wasn’t open to you. Luckily, as a global decentralised digital trading platform, anyone is able to trade on this lucrative market from the comfort of their own home.

 

What time does the forex market open?

 

As a globally interconnected market, the forex market needs to be able to incorporate all four of the world’s major time zones. As such, the market is open 24 hours a day from Monday at the following times (times given in GMT):

  • London – 8am
  • New York – 1pm
  • Sydney – 10pm
  • Tokyo – 12am

 

When does the forex market close?

 

The market is open 24 hours throughout the working week (Mon-Fri), closing on a Friday at the following times (GMT):

  • London – 5pm
  • New York – 10pm
  • Sydney – 7am
  • Tokyo – 9am

The market can therefore be accessed at any time that’s convenient for the trader throughout the working week with the help of a forex broker.

 

What is a forex broker?

 

Also known as retail forex brokers or currency trading brokers, forex brokers are firms that provide individual traders with access to a forex trading platform. In return for executing your trades, the broker will charge a commission per spread.
A pair of glasses in front of a laptop displaying forex charts
‘What is forex trading?’ is a big question with a long and complex answer. Hopefully this guide will have cleared this up, along with any other questions you had about the inner workings of the world’s most liquid trading market. Of course, there’s still so much to learn – and to take the next step, you can simply sign up for one of our free, expert-led seminars right here.