Forex trading is the buying and selling of currencies to speculate on changes in their exchange rates. Instead of trading a single currency on its own, forex traders trade one currency against another in pairs such as EUR/USD, GBP/USD and USD/JPY.
So, what is forex trading in practice? You take a position based on whether you expect a currency pair to rise or fall. If the market moves in your direction, you can make a profit. If it moves against you, you can lose money.
- How Does Forex Trading Work?
- What Is a Currency Pair?
- What Makes Forex Prices Move?
- How Do Forex Traders Make Money?
- What Are Pips, Spreads and Trading Costs?
- What Is Leverage in Forex Trading?
- What Are Forex Market Hours?
- What Are Liquidity and Volatility in Forex?
- Frequently Asked Questions
- Start Learning Forex
The foreign exchange market is one of the world’s largest financial markets, with trillions of dollars traded globally each day. The Bank for International Settlements (BIS) provides detailed data on activity in the global foreign exchange market. BIS Triennial Central Bank Survey
How Does Forex Trading Work?
Forex trading is based on the relative value of two currencies.
Every forex trade involves a currency pair. The first currency is the base currency, while the second is the quote currency.
For example, in EUR/USD:
- EUR is the base currency.
- USD is the quote currency.
If EUR/USD is trading at 1.1500, one euro is worth 1.15 US dollars at that quoted price.
If you expect the euro to strengthen against the dollar, you could buy EUR/USD. If the pair rises, the trade moves in your favour. If you expect the euro to weaken, you could sell EUR/USD. If the pair falls, the trade moves in your favour.
Your actual profit or loss depends on how far the market moves, the size of your position and the costs associated with the trade.
What Is a Currency Pair?
A currency pair shows the value of one currency relative to another.
Take EUR/USD as an example.
- EUR is the base currency.
- USD is the quote currency.
If EUR/USD is quoted at 1.1500, one euro is worth 1.15 US dollars at that quoted rate.
If the price moves to 1.1600, the euro has strengthened relative to the dollar. If it falls to 1.1400, the euro has weakened relative to the dollar.
The same principle applies to pairs such as GBP/USD, USD/JPY and AUD/USD.
Major currency pairs
Major pairs generally include the US dollar and another major global currency.
Examples include:
- EUR/USD
- GBP/USD
- USD/JPY
- USD/CHF
- AUD/USD
- USD/CAD
- NZD/USD
These are among the most widely traded currency pairs.
Minor currency pairs
Minor pairs, also known as cross pairs, do not include the US dollar but combine other major currencies.
Examples include:
- EUR/GBP
- EUR/JPY
- GBP/JPY
- AUD/JPY
Exotic currency pairs
Exotic pairs generally combine a major currency with the currency of a smaller or emerging economy.
Examples include USD/TRY and USD/ZAR.
Liquidity, spreads and volatility can differ significantly between major, minor and exotic pairs, so the type of pair is worth considering before opening a trade.
What Makes Forex Prices Move?
Understanding what moves currencies is one of the most important parts of forex trading.
A currency can strengthen or weaken as traders change their expectations about an economy, its central bank and the wider global market.
Interest rates and central banks
Interest rates are one of the biggest drivers of currency markets.
When a central bank changes its policy rate, or signals that rates could change in the future, traders reassess the relative attractiveness of that currency.
This is why decisions from central banks such as the Federal Reserve, Bank of England, European Central Bank and Bank of Japan can cause significant moves in currency pairs.
The rate decision itself is not always the most important part. Traders also study central-bank statements, economic projections and comments from policymakers for clues about what could happen next.
For current monetary-policy information, traders can refer directly to sources such as the Federal Reserve, Bank of England, European Central Bank and Bank of Japan.
Inflation
Inflation can influence currency prices because it affects expectations for interest rates.
If inflation remains higher than expected, traders may anticipate that a central bank will keep rates higher for longer. If inflation falls, expectations can change in the opposite direction.
These changes in expectations can affect the value of a currency.
Employment and economic growth
Employment reports, GDP figures, retail sales and other economic indicators can also move currencies.
Stronger or weaker economic data can change expectations about monetary policy. This is why many forex traders check an economic calendar before opening a position.
For US economic releases, the U.S. Bureau of Labor Statistics provides official data on indicators including employment and inflation.
Commodities
Commodity prices can also affect currencies, particularly in economies that rely heavily on commodity exports.
Oil is one example. Significant changes in energy prices can influence inflation and economic expectations, which can then affect interest rates and currencies.
Geopolitical events
Geopolitical developments can cause sudden changes in market sentiment.
Wars, sanctions, trade disputes and other major events can affect currencies by changing expectations about economic growth, trade and risk.
This can also increase volatility across several markets at the same time.
How Do Forex Traders Make Money?
Forex traders attempt to profit from changes in the exchange rate between two currencies.
Suppose you buy EUR/USD at 1.1500 because you expect the euro to strengthen. If the pair rises to 1.1600 and you close the position, the price movement is in your favour.
The reverse applies to a short position. If you sell EUR/USD because you expect the pair to fall, a decline in the price can work in your favour.
However, the direction of the trade is only part of the calculation. Position size matters. A larger position creates greater exposure to the market, meaning the same price movement can produce a larger gain or loss.
Trading costs also affect the final result.
There is no guaranteed way to make money from forex trading. The CFTC’s forex guidance highlights the risks of leveraged forex trading and advises traders to research dealers carefully before depositing funds.
What Are Pips, Spreads and Trading Costs?
What is a pip?
A pip is a standard unit used to measure movement in many forex pairs.
For most major currency pairs, a pip is typically the fourth decimal place. For example, a move in EUR/USD from 1.1500 to 1.1510 represents a movement of 10 pips.
JPY pairs are generally quoted differently, with the second decimal place commonly representing a pip.
The monetary value of a pip depends on factors such as the currency pair and position size.
What is the spread?
The spread is the difference between the bid price and ask price of a currency pair.
For example, if EUR/USD has a bid price of 1.1500 and an ask price of 1.1502, the spread is 2 pips.
The spread is one of the costs to consider when trading. It can change depending on the instrument, liquidity and market conditions.
Other costs can also apply depending on the trading provider and account, including commissions, overnight financing or currency conversion charges.
What Is Leverage in Forex Trading?
Leverage allows you to control a larger position with a smaller amount of capital used as margin.
For example, with 10:1 leverage, $1,000 of margin could provide exposure to a $10,000 position.
This does not make a trade more likely to succeed. It increases your exposure, meaning that a relatively small market movement can have a larger effect on your account.
The CFTC explains that leverage can amplify both gains and losses in margin-based forex trading. Read the CFTC’s forex risk guidance.
For a more detailed explanation, read What Is Leverage in Forex Trading?.
What Are Forex Market Hours?
The forex market operates across major financial centres around the world, with trading activity moving between different regions during the week.
The major trading sessions are commonly referred to as:
- Sydney
- Tokyo
- London
- New York
The level of activity can change throughout the day. Market overlaps can bring increased trading activity and liquidity, while some periods can be quieter.
Economic announcements can also cause activity and volatility to increase regardless of the normal session pattern.
For this reason, traders often consider both when they are trading and what events are scheduled during that period.
What Are Liquidity and Volatility in Forex?
Liquidity refers to how easily an asset can be bought or sold without causing a significant change in its price.
Volatility describes how much and how quickly the price of an asset moves.
Major currency pairs generally have significant trading activity, while less-liquid pairs can behave differently. Volatility can also increase around major economic releases, central-bank decisions and unexpected global events.
Higher volatility can create more trading opportunities, but it can also increase risk.
The BIS’s latest Triennial Central Bank Survey provides a useful overview of activity and structure in the global foreign exchange market. Explore the BIS FX survey.
How Risky Is Forex Trading?
Forex trading involves risk. Currency prices can move against your position, sometimes quickly.
Leverage can increase the impact of these movements because your market exposure can be larger than the capital used as margin.
This makes position size and risk management important parts of trading.
A trader should understand how much exposure a position creates before entering a trade. Stop-loss orders can also help define an exit level if the market moves against the trade, although they cannot guarantee an exact execution price in every market condition.
It is also important to research the provider you are using, understand its trading conditions and review its risk disclosures before depositing funds. The CFTC specifically warns traders to research forex dealers and be alert to fraudulent offers, including promises of guaranteed or unusually high returns. Read the CFTC’s forex fraud guidance.
Before trading with real money, practising in a demo environment can also help you become familiar with the platform, order types and how your strategy behaves under different market conditions.
For more practical guidance, read How to Trade Forex and CFDs Safely.
Forex Trading vs Forex CFDs
Forex trading refers broadly to trading currencies and speculating on changes in exchange rates.
A CFD, or contract for difference, is a derivative that allows traders to speculate on the price movement of an underlying market without owning the underlying asset.
Forex CFDs allow traders to speculate on currency-pair movements through a leveraged product.
The products, leverage limits and trading conditions available to you depend on the provider and your jurisdiction.
The UK Financial Conduct Authority describes CFDs as high-risk products that are not suitable for all retail consumers and highlights the risks associated with leverage.
How Do You Start Trading Forex?
Learning how forex works should come before putting real money into the market.
Start by understanding currency pairs, price movements, spreads, leverage and the economic events that can move currencies. It is also useful to learn how orders work and how to calculate the potential risk of a position.
A demo account can then give you an opportunity to practise without risking real capital. You can use it to become familiar with the trading platform, test an approach and see how different market conditions affect your positions.
If you decide to trade live, make sure you understand the provider’s available instruments, trading costs, leverage and risks before opening a position.
Trading Forex With Farlo
Farlo gives traders access to forex and other markets through its trading platform.
Farlo accounts can be connected to MetaTrader 5 (MT5) for trading. If you use MT5, follow our guide to connect your Farlo account to MetaTrader 5.
Not ready to trade live yet? You can explore the Farlo demo account and practise with virtual funds.
Before trading live, understand the instrument you’re trading, the size of your position, the leverage involved and the potential for loss.
Frequently Asked Questions
Forex trading is the buying and selling of currencies to speculate on changes in their exchange rates. Currencies are traded in pairs, such as EUR/USD or GBP/USD.
Forex trading involves taking a position on the expected movement of one currency relative to another. You can buy a currency pair if you expect its price to rise or sell it if you expect the price to fall.
Traders can make gains when their positions move in their favour, but forex trading also involves the risk of loss. Leverage can increase the effect of market movements on an account.
There is no universal amount. Minimum deposits and trading conditions vary between providers. The amount you can afford to risk is also different for every trader.
A currency pair shows the value of one currency relative to another. EUR/USD, for example, compares the euro with the US dollar.
Leverage allows traders to control a larger position using a smaller amount of capital as margin. It increases market exposure and can increase both potential gains and losses.
Start Learning Forex
Understanding forex trading starts with understanding the market itself.
Learn how currency pairs work, what moves exchange rates, how trading costs affect your position and how leverage changes your exposure. Once you understand those basics, you can practise in a demo environment and build your knowledge before deciding whether to trade with real money.
For more forex education and trading guides, explore the Farlo Learn library.
