What is forex trading? forex trading allows traders to speculate on the future price of a particular currency pair. Popular currency pairs include the EUR/GBP and the GBP/USD. When the trader speculates correctly, they can cash out their forex position and make a profit. However, forex trading can be a complicated affair, especially for beginners.
In this guide, we will understand what is forex trading and how it works. We will also look at popular trading pairs, along with popular trading strategies.
Lastly, we will look at our pick for the best platform to trade forex. Let’s get started.
What Is Forex Trading: Key Points
- The forex markets are the world’s largest and most liquid markets. This can be attributed to the worldwide reach of trade, commerce, and finance.
- The forex market can be described as a global marketplace for exchanging national currencies.
- Forex markets generally exist as spot and derivatives markets. Both markets offer futures, forwards, options, and currency swaps.
- Currencies trade against one another as exchange rate pairs. For example, the EUR/USD currency pair trades the Euro against the US Dollar.
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What Is The Forex Market?
Before moving ahead with our guide on what is forex trading, let’s understand the forex market a little better. The word ‘forex’ is a combination of foreign currency and exchange. Similarly, foreign exchange is the process through which traders exchange one currency for another, usually for commerce.
According to a Bank for International Settlements (BIS) report, the daily global volume for forex trades reached $7 trillion in 2023.
The foreign exchange market is where currencies are traded with each other. The market is unique because it lacks a centralized marketplace. Instead, currency is traded electronically, over the counter (OTC). All transactions on the forex market occur through computer networks among traders worldwide rather than a single centralized exchange.
Forex markets are open 24 hours a day, with currencies traded in all major financial centers worldwide. This means the forex markets are highly active during most times of the day. As mentioned earlier, an interesting aspect of forex is that it does not have a physical nerve center. Instead, the market consists of terminals and computer networks. Participants in the forex market typically consist of commercial banks, investment banks, and retail investors.
Forex Trading: Looking At The Basics
So far in our guide on what is forex trading we have gone over the definition of forex markets and how traders speculate on the future price of a currency pair. Let’s look at this in action, using the EUR/USD pair as an example.
Let’s assume the EUR/USD pair is trading at 1.0025. For every Euro exchanged, the trader receives $1.0025 in return. Forex traders are tasked with determining if the EUR/USD price will rise or fall. If the trader predicts that the price will rise, and it increases, the trader will make a profit on the trade.
Types Of Forex Pairs
There are several forex pairs available to traders. However, all of them fall within three core categories.
- Majors – These currency pairs are the most liquid and contain the US Dollar alongside another major global currency such as the Euro or the GBP.
- Minors – These currency pairs contain two major currencies, but neither is the US Dollar. An example of a minor pair is the EUR/GBP.
- Exotics – Exotic pairs are the least liquid currency pairs. These pairs contain at least one currency from an emerging economy, such as the USD/TRY.
A pip is another critical factor to understand when it comes to forex markets. The price of forex pairs changes every second. This is why they are traded in pips. Pips represent the currency unit after the decimal point. For example, if the trading pair’s price goes from 1.3000 to 1.3001, it represents a movement of 1 pip.
Traders must specify a stake when speculating on a forex position. The stake is the amount of money the trader is willing to risk on a position. The best forex traders in the market allow traders to enter positions at 0.01 lots. A standard lot consists of 100,000 units of the base currency being traded.
When it comes to strategy, a majority of forex traders are day traders. These traders open and close a position before closing, with trade durations lasting from a few minutes to a few hours. Swing trading is also highly popular in forex.
Types Of Forex Trading
Next in our guide on what is forex trading are the types of forex trading. The forex markets are traded primarily through spot, forward, and futures markets. The spot market is the largest of all three markets because it is the underlying asset on which forwards and futures markets are based. When talking about forex, people typically refer to the spot market. Forwards and futures markets are popular with companies and financial firms that hedge their foreign exchange risks to a specific futures date.
In the spot market, currencies are bought and sold based on their trading price. The price is determined by supply and demand and calculated on factors such as
- Current interest rates
- Economic performance
- Geopolitical sentiment
- Price speculation
A futures contract is a standardized agreement between two parties to take delivery of a currency on a pre-decided date and price—futures trades on exchanges and not via OTC trades. In the futures markets, futures contracts are brought and sold on a standard size and settlement date on public commodities markets such as the Chicago Mercantile Exchange (CME).
A forward contract is a private agreement between two parties to buy a currency at a future date and predetermined price in the OTC markets. In the forward markets, contracts are bought and sold OTC between two parties.
How Does Forex Trading Work?
The next part of our guide on what is forex trading deals with how it works. Every day, trillions of dollars worth of currencies change hands between traders. Large banks and financial institutions dominate the bulk of this forex market. These institutions are primarily responsible for driving the forex market in terms of demand and supply. However, other factors, such as macroeconomic factors and geopolitical events, also influence the price of a currency pair.
For example, prolonged concerns about a global recession have put demand for the USD at record levels. This means it has gained strength against nearly all international currencies. The Euro also recently went below parity with the USD. This marked the first time in history when 1 USD was worth more than 1 Euro.
Such events allow investors to capitalize on fluctuating currency prices. However, it isn’t all that straightforward. Traders must know which way a currency pair’s price would move. Experienced traders assess the price of a particular trading pair through chart evaluation and technical analysis. These traders look at historical trends and how they stack up against current pricing levels.
Traders use several economic indicators such as RSI, MACD, Bollinger bands, moving averages, and others to achieve their trading goals. These indicators help assess a range of real-time data dealing with volatility, volume, and support/resistance levels.
Forex Trading Explained
Next in our guide on what is forex trading, let’s understand the concepts around forex trading. Traders must consider several factors to have a strong grasp of forex trading. This includes currency pairs, pips, leverage, order types, etc. Let’s look at each in a little more detail to understand what forex trading is about.
What is a pip? Pip is short for “percentage in point” and refers to the last decimal point of a forex pair quote. A pip is usually four digits after the decimal point in all currencies except the Japanese Yen. Let’s look at an example to understand better. Suppose the price moves from 1.5000 to 1.5002. It represents an increase of 2 pips. On the other hand, a move from 1.7950 to 1.7946 would mean a fall of 4 pips.
Some forex brokers offer traders 5 units after the decimal point. This allows traders to enter even smaller stakes, lowering the barrier of entry. However, the Japanese Yen is different. In the case of this currency, brokers generally offer quotes of two or three units after the decimal point. For example, the USD/JPY pair would be shown as 130.55 or 139.558. A pip is equal to 1/100th of 1%. In some cases, this is described as a basic percentage point.
While leverage is a risky tool, without it, forex trading would be a challenge for traders on a limited budget. The reason behind this is that currencies are traded in lots, which are equal to 100,000 units of the base currency. For instance, when trading the EUR/USD trading pair, the base currency is the Euro. Banks and financial institutions will trade this pair in lots of 100,000 units, each worth €100,000.
Many online brokers offer a minimum trade requirement of 0.01 lots. However, trading a currency pair such as the EUR/USD still requires an outlay of €1,000. This is where leverage comes into the picture. Leverage allows the trader to enter into a position worth more than what they have in their brokerage account. Let’s understand this with the help of an example.
Suppose a trader wants to meet the minimum lot size of 0.01 on the GBP/USD trading pair. This would require the trader to put up a stake of £1,000. To do this, the trader decides to apply a leverage of 10:1. As a result, even if the trader is entering a position worth £1,000, they only risk 10% of this amount, which is £100.
Pros And Cons Of Leverage
However, traders must remember that leverage comes with its pros and cons. On the upside, traders can access a larger forex position, even though their account balance would be considerably lesser. However, leverage can also lead to significant financial loss. If the trader utilizes leverage of 10:1, they must only put 10% of the position size up front. However, the broker would likely liquidate the position if the trade value declines by 10%. As a result, the trader could lose their entire stake. In most cases, the broker does not offer negative balance protection.
Leverage limits depend on three primary factors.
- Retail clients are offered significantly lower leverage compared to professional or institutional traders.
- Major pairs have considerably higher leverage limits compared to minor and exotic pairs.
- Jurisdiction limits are also applicable. For example, retail clients in the US can access leverage of up to 50:1 on major currency pairs. However, in the UK, Australia, and Europe, leverage is capped at 30:1.
When a trader has decided on the forex pair they wish to speculate on, they must create an order. Traders can choose between a long order or a short order. This lets the broker know if the trader believes the currency pair will rise or fall in value. Let’s look at each order in a little more detail.
When a trader places a long order, they purchase the trading pair. As such, they believe the trading pair’s value will register an increase. When the trader places a short order, the trader is selling the pair. As such, the trader believes the currency pair’s price will decline.
Traders are also advised to deploy order types when creating a position. For example, the broker will require traders to choose between a limit or a market order. A limit order allows the trader to select the price at which they want the trade to be executed. If the GBP/USD trading pair is at 1.1601, the trader might wish to enter a position once it hits 1.1630. This means the limit order will be deployed when this price is triggered.
On the other hand, a market order instructs the broker to execute the trade instantly. As a result, the trade will be executed at the next best available price. This could be slightly higher or lower than the original quote.
Now, let’s understand currency pairs. Before we begin with a forex trading account, it is imperative to have an understanding of how currency pairs work. As we have mentioned, each currency pair comprises two different currencies: EUR/USD or GBP/USD. If we use GBP/USD, the British Pound is the base currency, while the USD is the quote currency. This means that if the GBP/USD is trading at 1.1670, for every £1 traded, $1.1670 will be returned.
If you are new to forex trading, it is advisable to trade major currency pairs. This is because these pairs have the highest level of liquidity in the forex market. Each major pair contains the US Dollar and another strong currency.
Minors also consist of strong currencies like the Euro and the Canadian Dollar. However, because these pairs do not contain the USD, liquidity levels are low compared to major currency pairs.
Liquidity is a crucial concept to learn before getting into forex trading. The more liquidity associated with a particular pair, the less its volatility. Additionally, major forex pairs also offer the most attractive spreads.
Forex brokers also offer access to exotic pairs besides major and minor pairs. Exotic pairs allow traders to speculate on the future value of currencies from smaller countries. These include Turkey (TRY), Argentina (ARS), and South Africa (ZAR). For example, the USD/TRY pair has gone from $8.28 to $18.21 in just a year. This means the Turkish Lira has dropped over 54% in value against the Dollar in just a year.
Spreads is another term traders will repeatedly come across. The spread refers to the difference between the bid and ask price of the traded currency pair. In simple terms, each forex pair will have two prices attached to it when trading. The spread is the markup that brokers make on each position entered. Traders must always opt for brokers that offer tight and competitive spreads. This results in highly cost-effective trading fees. Spreads are typically determined by the liquidity in the markets.
For example, the EUR/USD pair is the most traded currency pair in the world. This means it comes with competitive spreads under 1 pip. However, exotic pairs are highly volatile and come with spreads equal to dozens of pips. Let’s look at how spreads can impact trading profits with the help of an example.
Suppose a trader is looking to speculate on GBP/USD. The forex broker used for the trade quotes a bid price of 1.1576. Meanwhile, the ask price on the trading pair is 1.1578. This means the spread associated with this pair is 2 pips. Now, let’s look at what happens when a trade is opened.
Let’s assume the trader predicts the value of GBP/USD will increase. As a result, they get a price of 1.1578. However, the trader can cash out their position at a price of 1.1576. This means as soon as the trade is opened, the position is down by 2 pips. As a result, the trader would need to make gains equal to 2 pips to break even.
Profit And Loss
Some forex traders attempt to calculate the profit and loss by the number of pips moved by the currency pair. However, the easiest way is to focus on the percentage gain or loss of the pair in question. Then, this can be multiplied by the stake and the leverage utilized on the position. Let’s look at how traders can calculate profit and loss with the help of a couple of examples.
- Let’s assume the trader is going long on the USD/CAD trading pair at 1.3160.
- The position is worth $10,000 with a 10:1 leverage. This means the stake amounts to $100.
- After a few hours, USD/CAD is trading at 1.3423.
- This marks an increase of 2%, following which the trader closes his position.
- This means that on a position size of $1000, the trader makes 2% ($20)
- In this example, the trader is going short on the GBP/USD pair at $1.1601.
- The position is worth $50,000, with a leverage of 50:1. This means the stake is $1000.
- After some time, the GBP/USD pair registers a decrease and is trading at 1.1484.
- This indicates a reduction of 1%, following which the trader closes the position.
- This means on a position size of $50,000, the trader makes 1% ($500).
Popular Forex Pairs to Trade
The next part in our guide on what is forex trading covers popular forex pairs.
The GBP/USD was the most traded currency pair and is nicknamed the “Channel.” It contains two of the world’s strongest currencies, the British Pound and the US Dollar. However, it has declined since the Brexit referendum held in 2016. Before Brexit, the GBP/USD currency pair was trading at just under 1.5000. Currently, it is trading at 1.1203.
The economy of the United Kingdom and the European Single Market have been closely aligned. This has been true even after the Brexit referendum. The sentiment is reflected in the price movement of the GBP/EUR currency pair, which has remained stagnant over the past 12 months of trading.
For example, the GBP/EUR currency pair was trading at 1.1627 in the previous year. Currently, the pair is trading at 1.1509.
The USD/TRY currency pair is highly volatile and not for the faint-hearted. This currency pair pits the US Dollar against the Turkish Lira. At the end of 2022, the currency pair traded at $17.76, significantly declining over 2022. This is because the Turkish economy suffered from rising unemployment and runaway inflation. However, some seasoned currency speculators look forward to the volatility associated with the pair, thanks to the swing trading opportunities.
The USD/JPY currency pair, nicknamed the Gopher, is a heavily traded pair that has historically generated considerable liquidity.
The currency pair comprises the US Dollar and the Japanese Yen as the base and quote currency. In 2022, the Yen saw a substantial decline against the US Dollar, falling by over 26%. Currently, the pair is trading at 150.50.
The EUR/USD, also called the “Chunnel,” is the world’s most traded forex pair. This pair consists of the world’s strongest currencies, the US Dollar and the Euro. This makes it the best forex pair to trade, thanks to the unprecedented amount of liquidity it attracts. This means it is significantly less volatile than other currency pairs and offers highly competitive spreads.
However, even this currency pair can experience volatility. In Q3 2022, an unprecedented event occurred when the EUR/USD currency pair fell below parity. Currently, the EUR/USD currency pair is trading at 1.0679.
75% of retail investor accounts lose money when trading CFDs with this provider.
Popular Forex Trading Strategies
This section will cover popular forex trading strategies. Forex trading is a highly competitive and complex space that requires a robust understanding of what impacts currency price movements. Successful forex traders also use risk management strategies to ensure maximum gains and minimal losses. In this section of our guide on forex trading, we will look at popular trading strategies traders implement.
One area of risk management that investors must consider when trading forex is related to the trader’s bankroll and its management. The trader’s bankroll is the amount of money they have in their brokerage account. A viable bankroll strategy can determine the maximum amount of capital risked on a forex position. Let’s understand this with an example.
Let’s assume the trader deposits $5000 into their forex broker account. After this, the trader sets a sentiment bankroll management limit of 2% per trade. This means the trader’s maximum trade position is $100. Depending on the trader’s account balance, this maximum trade position will rise or fall.
Let’s assume the trader closes a position and their bankroll is $5200. Keeping the 2% cap in mind the maximum trade size would increase to $104. This strategy ensures the trader does not go through their entire bankroll recklessly. As the bankroll declines, so does the maximum stake permitted and vice versa.
Third Party Systems
Those trading forex for the first time would not have experience in deploying technical or fundamental analysis strategies. It would be wise for such traders to look at deploying third-party systems. Traders can start by exploring forex signals. These signals provide trading suggestions curated by seasoned currency analysts. An excellent place to get started with forex signals would be Learn2Trade. Learn2Trade provides up to five premium forex signals each day.
Let’s look at an example below.
- Pair – EUR/USD
- Position – Long
- Entry Price – 1.0010
- Stop-Loss Price – 0.9800
- Take-Profit Price – 1.2001
The above example contains all the information traders need to get started and place the suggested orders. As a result of such platforms, traders don’t require a knowledge of technical analysis. Beginners can also consider deploying a forex trading bot. Trading bots are software programs that can place buy and sell orders.
Forex Trading Technical Analysis
Most of the experienced and highly successful forex traders employ technical analysis. Technical analysis involves analyzing price trends and charts to predict short-term price movements. To facilitate this, traders utilize indicators. These indicators assess specific metrics surrounding the relationship between two currencies. These metrics could be volume, volatility, and support or resistance levels.
For example, The RSI (Relative Strength Index) evaluates if a currency pair is overbought or oversold. If the RSI indicates that a trading pair is oversold, the declining pair could see a reversal. Another popular trading strategy is the Fibonacci sequence.
Stop-Loss And Take-Profit Orders
Beginner traders must have a firm grasp of stop-loss and take-profit orders. A majority of the best forex trading platforms offer these order types. Let’s look at each order type in a little more detail. Stop-loss orders allow traders to limit losses of an unsuccessful trade. For example, a trader deploys a stop-loss order to cap their potential loss to 3%. If the trade sees a 3% decline, the broker will automatically close the trade to prevent further losses.
Here is how to deploy a stop-loss order.
- Let’s assume the trader goes long on the GBP/EUR trading pair at 1.1559.
- However, the trader decides they do not wish to lose more than 1.5% on this trading position.
- As a result, they decided to enter a stop-loss order 1.5% below the entry price of 1.1159.
- This means the stop-loss order price would need to be set at 1.1385
According to the above example, if the GBP/EUR trading pair drops to 1.1385, the broker will close the position, capping losses at 1.5%.
On the other hand, take-profit orders are booked to lock profits. The trader must determine the price at which they want to close the trade. Once done, the broker will execute the trade when the price reaches the desired level. Let’s look at how to deploy a take-profit order.
- Let’s assume the trader goes long on the GBP/EUR trading pair at an entry price of 1.1559.
- The trader wishes to make a profit of 4% on this position.
- As a result, the trader enters a take-profit order 4% above the entry price.
- This means the take-profit order will be set at 1.2021.
According to the above example, if the GBP/USD trading pair reaches a price of 1.2021, the broker will close the position, resulting in a 4% profit for the trader.
Traders typically rely on technical analysis when it comes to forex trading. This can take months or even years to master completely. A good starting point would be understanding how fundamental news could impact the value of currencies. For example, the Brexit referendum brought considerable uncertainty to the UK economy. As a result, the GBP saw a rapid decline against other major currencies.
On a larger scale, we could look at the impact of the Covid-19 pandemic on the global economy. The pandemic led to considerable uncertainty in the international markets. This made the US Dollar a safe haven for investors. As a result, the US Dollar gained considerably against global currencies.
Risks Associated With Forex Trading
This section covers the risks associated with it. Forex trading is no different from other trading avenues regarding the risks involved. Traders must consider several risks before beginning their foray into forex trading. The main risks associated with forex trading are,
- Volatility – Some forex pairs, such as exotics, can be highly volatile. Beginners in forex trading should stick with major currency pairs with limited volatility.
- Negative Balance – Most forex brokers provide their users with negative balance protection. If traders use a provider that doesn’t offer this protection, an unsuccessful position or trade could see the trader owing a considerable amount of money to the broker.
- Risk of Loss – There is no guarantee of profit-making through forex trading. In fact, traders could lose some or even all of their initial deposit with the broker.
- Leverage – All of the major forex pairs permit the highest levels of leverage when compared to other asset classes and trading pairs. However, on the downside, this could result in an overuse of leverage, which sees amplified losses during unsuccessful trades.
- Delayed Pricing – Some forex brokers have a reputation for supplying delayed market data. Using such a broker would consistently put the trader behind the rest of the market when making crucial trades.
Where To Trade Forex – Best Forex Trading Platforms
In this section of our guide on what is forex trading, we will look at where you can trade forex. Suppose you want to begin forex trading. A good question to ask would be where you could start. Several brokers let you trade forex.
The only way to trade forex is to register with regulated brokers that offer low fees and small account minimums. The broker should also be user-friendly and offer educational and research tools. Our recommendation for a forex broker is eToro. Let’s look at the platform in a little more detail.
eToro – Overall Best Forex Broker For Copy Traders
eToro is widely regarded as the best forex broker for beginners. Opening an account on eToro takes minutes, after which funds can be easily deposited. eToro accepts several payment methods, such as debit cards, credit cards, e-wallets, and bank wire transfers.
The platform does not charge any deposit fees when deposits are made in USD. If deposits are made in other currencies, a 0.5% FX fee is levied. eToro supports 49 currency pairs. Most of these currency pairs are from major and minor markets. Additionally, the platform also supports a small number of exotic currency pairs. However, beginners must stay away from these currency pairs.
Fees On eToro
eToro operates on a spread-only basis. For example, the EUR/USD trading pair starts at 1 pip per slide. Leverage of up to 1:30 is offered to retail clients when trading major pairs and 1:20 on minor and exotic pairs. The minimum trade size when applying leverage of 1:30 is $33.33.
Real-time pricing charts are also available for all forex pairs supported by eToro. Experienced traders can access technical indicators and other tools to streamline trading strategies. Traders on the platform can also access market insights, financial news, webinars, and access to educational material. The platform also offers demo accounts, allowing traders to test their strategies.
To access the demo account, traders must switch to the platform’s demo mode. Demo mode allows traders to practice various trading strategies with a preloaded paper balance of $100k.
Another innovative feature on eToro that may interest traders is its copy trading feature. Copy trading allows traders to mirror the trades of experienced forex traders. Copy trading facilitates a passive yet profitable trading experience.
Apart from forex, traders on eToro can also invest in crypto. Traders can also invest in commission-free stocks, ETFs, commodities, and indices. The platform also offers a dedicated mobile application compatible with iOS and Android.
eToro is a highly secure and trusted platform. This is because multiple regulatory bodies regulate it. These include the FCA, ASIC, CySEC, and the SEC.
Pros And Cons Of eToro
Let’s look at some of the pros and cons of eToro forex broker:
- Supports over 49 currency pairs across majors, minors, and exotics
- Copy trading, allowing beginners to mirror trades of experienced traders
- Supports commission-free stocks, ETFs, and other assets
- Low trading fees with spreads starting at just 1 pip
- Real-time pricing charts and technical indicators
- Does not support forex trading bots
|Starts from 1 pip
|Free on deposits made in USD. 0.5% on deposits made in other currencies.
|1:30 for retail clients
|An inactivity fee of $10 is charged after 12 months of inactivity.
|Forex Pairs Supported
75% of retail investor accounts lose money when trading CFDs with this provider.
Conclusion – Forex Trading Explained
This guide has delved into the core basics of forex trading and discussed how traders can begin trading currencies. We have also covered important principles such as currency pairs, pips, spreads, leverage, and technical analysis. This guide aims to ensure that beginners have the right tools to trade forex in a risk-averse manner.
Those looking to begin forex trading must consider a secure and regulated platform like eToro. eToro supports commission-free trading across 49 currency pairs. Additionally, it requires a fee-free minimum deposit of just $10 and offers a demo account.
Reviewed and Fact Checked by Wajeeh Khan, Fintech, Blockchain Writer and Investment Analyst.
- Free Copy Trading of Professional Traders
- Best Forex Broker
- Minimum Deposit only $10
75% of retail investor accounts lose money when trading CFDs with this provider.
FAQs About Forex Trading
What Time Is The Forex Market Open?
Trading hours in the forex market are from Sunday 5 PM ET to Friday 5 PM ET. However, the forex market never technically closes. As a result, several brokers offer out-of-hour trading.
Is Forex Trading Legal?
Yes. Forex trading is legal in most jurisdictions of the world. However, traders must ensure they are opening an account with an authorized and regulated broker that is authorized to offer services in their country.
What Is Forex Trading?
Forex trading lets traders speculate on the future value of currency pairs, such as the GBP/USD and EUR/USD. If the trader guesses the price movement correctly, they make a profit. The forex market is the world’s largest and most liquid market, with trillions of dollars worth of currency being traded daily.
Can Forex Traders Use Apps?
Several online brokers offer forex trading apps. No two apps are the same. This is why traders must choose a broker based on their requirements. Traders can use the app offered by eToro. The app is compatible with Android and iOS. Additionally, no commissions are charged across all supported pairs. The eToro app is one reason the platform is popular with beginners and experienced traders.
How Much Is The Forex Market Worth?
The forex market is the world’s most liquid market and sees $6 trillion worth of currencies exchange hands every day.