What is Forex Trading and How Does It Work?

Forex trading has become even more popular with retail traders like you wishing to get into the game of traders. In the simplest of terms, Forex trading (also referred to as FX), is the process of buying and selling currencies in order to make profits from their differences. All these transactions take place in the foreign exchange market which is the largest and the most liquid financial market in the world.

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What is Forex?

As earlier mentioned in this article, Forex trading refers to the act of buying one currency while simultaneously selling another, essentially swapping currencies on the global market, where you speculate on the price movements of currency pairs to with the aim of making a profit by predicting if a currency will rise or fall in value relative to another.

So as a forex trader, your main purpose is speculating on the price movements of one currency against another with objective of making profit.

Key Forex Markets Facts

With more than $7.5 trillion, Forex actually stands as the world's most traded market. To give you a better understanding, the daily average volume of the S&P 500 is just $53 billion which represents just 2.27 % of the size of forex.

1. You Might have Traded Forex

Each time you travel to another nation, you often exchange your money into the foreign currency to spend money there. Once your stay in the country is over and you still have some of their currency left with you, you still end up converting back to your home currency. This is actually Forex.

2. Currencies Come In Pair

In Forex, you are always trading one currency against another, like for example, the US Dollar against the Japanese Yen (USDJPY).

3. The FX Market never sleeps

The Forex is open for trading 24 hours a day and for 5 days a week, from Sunday 5PM to Friday 5PM. The forex market does not sleep because the time zones of the main trading centers overlap with each other. So when one closes, another one opens and that is how it goes around.

4. There are always potential opportunities

Forex is a market full of liquidity as it reacts all the time and this makes it very attractive to day traders in search of short-term wins.

ALSO READ: What Is Margin Trading and How Does It Work?

How Does Forex Trading Works?

Forex Trading normally works like any other transaction where you are buying an asset using a currency. In the case of forex, the market price is the key determinant of how many of one currency is needed to purchase another. Like for example, the current market price of the GBP/USD currency pair shows how many US dollars it would take to buy a single pound.

Since currency names are a little long, each currency pair has its own code, which lets traders easily and quickly identify it as part of a pair.

What is The Spread In Forex Trading?

The spread in Forex trading is the difference between the buy and sell prices that the broker provides you with. Like for example, the buy price of currency pair might be 1.3429 and the sell price might be 1.3422. For your position to be profitable, you will need the market prices to either rise above the buy price or fall below the sell price - with respect to whether you went short or long.

What is Margin?

Margin is referred to as the initial deposit you need to put up in order to open and maintain a leveraged position. It is thanks to Margin and leverage that one trader can open large positions without having the total amount of money needed but by just putting in part of the amount needed to enter the trade.

ALSO READ: Introduction to Financial Markets: An Ultimate Guide

What Does It Mean to Buy Or Sell a Currency Pair?

Buying a currency pair simply means that you expect price to rise, indicating that the base currency is strengthening relative to the quote currency. On the other hand, selling a currency means you are speculating on price to fall and this can only happen if the base currency weakened against the quote currency.

Types Of Currency Pairs

Forex Trading pairs are categorized into three types: Majors, Minors, and Exotic Pairs.

Major Currency Pairs

From the name, you can already understand that the "Majors" are the most popular traded currency pairs. They account for about 85% of the total FX trading volume and are represented by some of the world's largest economies.

Around a quarter of all forex trades are in EUR/USD.

• EUR/USD – the euro vs the US dollar 
• USD/CAD – the US dollar versus the Canadian dollar
• USD/JPY – the US dollar versus the Japanese yen
• GBP/USD – British pound sterling versus the US dollar
• AUD/USD – the Australian dollar versus the US dollar 
• USD/CHF – the US dollar versus the Swiss franc

Since they feature amongst the most traded currency pairs, you might notice that the major pairs have the tightest spreads and for this reason they are less costly to trade as compared to other forex pairs.

Minor Currency Pairs

Minor pairs are currency pairs that do not include the US dollar. They are also referred to as cross pairs. Below are some examples of Minor currency pairs:

• GBP/AUD – British pound sterling versus the Australian dollar
• GBP/JPY – British pound sterling versus the Japanese yen
• CHF/JPY – the Swiss franc versus the Japanese yen
• EUR/NZD – the euro versus the New Zealand dollar
• EUR/GBP – the euro versus British pound sterling
• EUR/CHF – the euro versus the Swiss franc
• CAD/JPY – the Canadian dollar versus Japanese yen

Since they are less traded as compared to the majors, their spreads are often wider and this makes it a little costly for forex traders.

Exotics

Exotic currency pairs are made up of a major currency and a much more less traded one, like the US dollar versus the Chinese Yuan (USD/CNH).

Many of the smaller currencies are usually from developing countries or small nations with a strong economy. since they are barely traded, they often have the highest spread.

Examples of Exotics include:

• GBP/PLN – British pound sterling versus the Polish zloty
• USD/MXN – the US dollar versus the Mexican peso
• USD/THB – the US Dollar versus the Thai Baht
• EUR/RUB – the euro versus the Russian ruble
• GBP/SEK – British pound sterling versus the Swedish krona
• EUR/RON – the euro versus the Romanian leu

Exotic pairs can be suitable for experienced traders.

Closing Remark On What is Forex Trading and How Does It Work?

Forex trading is a dynamic and exciting market full of opportunities with every market move, but it requires knowledge, discipline, and good risk management. New traders should start with a demo account, learn market fundamentals, and use risk-management strategies before trading with real money.

Would you like a deeper explanation of any specific aspect? you can check out our other articles sure you will find what you need.