What is forex?
Forex, short for ‘foreign exchange,’ refers to the global market where currencies are bought and sold. In simple terms, forex means changing one currency for another. For example, if you have ever taken an overseas holiday and swapped the currency you normally use for the local currency of the place you are visiting, that’s a forex transaction in action!
Of course, forex (also known as ‘FX’) is much more than just holiday money. In fact, the forex market is the largest and most liquid financial market in the world, with trillions of dollars flowing through it every day. From international business payments to individuals ordering online goods from overseas, foreign exchange is one of the keys to global commerce and investment across every country and currency, from the Baht to the Yuan.
What is the forex market?
The forex trading market is not a physical marketplace. Instead, it is a decentralised global network that operates 24 hours a day, five days a week. In the forex market, traders buy and sell currency pairs based on how much value they have in relation to one another.
For example, if you live in the USA and are travelling to Europe, you will use your US dollars (USD) to buy euros (EUR). In the forex market, that transaction is represented by the symbols EUR/USD.
Because the forex market operates on a decentralised model with no physical control point or central exchange, no one person or organisation controls it. Instead, electronic transactions take place directly between two parties; this is called an ‘over the counter’ (OTC) market. You can think of it as a vast digital network where transactions flow freely between banks, financial institutions, and individuals around the world.
A wide number of factors influence the value of currencies on the foreign exchange market; inflation, economic growth, consumer confidence in a particular country, unemployment data, and even house prices can all contribute to where a currency sits on the market.
To help understand the movements of the forex market, you can refer to a forex economic calendar and see how price changes correlate with events like news releases and the publication of economic data.
The global nature of the forex market means it operates 24 hours a day, with the busiest times for transaction volume shifting between major financial centres across different time zones.
What are the different types of forex markets?
The three types of FX markets available for trading are as follows:
- Forex spot market: This is the largest market in the world, and you may have been a part of it without even knowing it. Any time someone goes to a bank to exchange currencies, they participate in the forex spot market.
- Forex futures market: A currency pair of a predetermined size is bought or sold under a futures contract at a specific time and date. This market operates on futures exchanges around the world, where the contracts are traded. These are legally binding contracts, allowing the seller to take on the risk that the price of the currency will fluctuate in the spot market before the contract’s end date.
- Forex forwards market: This market operates between a customer and a bank, or between two banks. Unlike futures, where they have standardised features in size and date, forward contracts are flexible and customised to fit a trader’s requirements.
What causes the price of currencies to move in forex markets?
In today’s highly interconnected and globalised economy, the prices of trading instruments, including forex pairs, are constantly moving and fluctuating.
Trading volume and transactions in the FX markets are always affected by supply and demand, and, like any other financial market, the higher the demand for a currency, the higher its price will move. But there are also many other key factors that can affect the prices of currency pairs. Some of these include:
- Central bank decisions: Central banks across the globe are responsible for setting interest rate levels for each country. In the forex trading market, traders generally prefer currencies with high-interest rates compared to other currencies. If trading forex, it’s a good idea to monitor the central banks related to the ‘major’ currency pairs: the US Federal Reserve, Bank of England (BoE), Bank of Canada (BoC), European Central Bank (ECB), Reserve Bank of Australia (RBA), Bank of Japan (BoJ), Swiss National Bank (SNB), and Reserve Bank of New Zealand (RBNZ).
- Economic data: Employment numbers, gross domestic product (GDP) levels, inflation, business sentiment, and consumer sentiment, all tend to affect the movement in currency pairs. Monitoring the economic calendar and market trends on your online trading platform helps keep you up to date with major economic data releases.
- Trading sessions: It is commonly known that trading volumes and activities can be ‘thin’ or slow during the market open in the Japan/Asia time zone. Trading volumes and activities usually increase when the UK/Europe session begins, and liquidity will be at its peak towards the close of the UK and the open of the US session. The London and New York sessions are usually the most active due to the time overlap between these major financial hubs. During certain forex market hours, some currencies are more liquid, e.g., JPY during the Tokyo session or GBP during the London session.
- Geopolitical factors: Wars, political crises, global unrest, and other related events can also impact the foreign exchange markets. Some currencies tend to do well when there is an elevated level of uncertainty in the markets, while others go in the opposite direction.
What time do forex markets open?
Forex markets are open 24 hours a day, five days a week. The official hours are from 5 p.m. EST on Sunday until 4 p.m. EST on Friday. EST refers to the time zone that is occupied by cities including New York, Boston, Atlanta, and Orlando in the US, and Ottawa in Canada.
You will also see the ‘UTC’ time zone mentioned whenever forex is discussed. This stands for “Coordinated Universal Time,” and it is aligned with what used to be GMT or Greenwich Mean Time. London, UK, is on UTC.
Since there is no ‘lead’ market, forex trading hours are based on when trading is open in a participating country. The London and New York trading sessions have some overlap, so there is often a lot of trading volume during that time of day. Foreign exchange rates are determined for the next 24-hour period at 4 p.m. London/UTC time.
How is the forex market regulated?
Even though it operates in over 180 countries, no single organisation is responsible for regulating the forex market. However, there are more than 50 governing and independent bodies around the world that supervise forex trading to ensure transparency and accountability.
Some top regulatory bodies overseeing foreign exchange activity include the Australian Securities and Investments Commission (ASIC), the Financial Conduct Authority (FCA) in the United Kingdom, and the Monetary Authority of Singapore (MAS). These regulatory bodies set standards for all financial services providers to abide by, such as regarding registration, licencing, and audit requirements, and can step in if a provider is found to be in breach of laws or regulations.
As a result of these authorities, forex traders have a higher degree of assurance that the trading service they subscribe to is fair and ethical.
What are the main forex currency pairs to trade?
The most well-known and most traded currency pairs are the 'majors'. This is a combination of the US dollar (USD) being traded against one of seven other major currencies: the Euro (EUR), British pound (GBP), Swiss franc (CHF), Japanese yen (JPY), Canadian dollar (CAD), Australian dollar (AUD), or New Zealand dollar (NZD). The four most popular currency pairs by volume are EUR/USD, USD/JPY, GBP/USD, and USD/CHF.
Currency pairs outside that group – mainly those that do not involve the US dollar – are considered 'minors' or 'exotics'. These pairs can still have high value and significant trading volume, but it is typically less when compared with the majors.
Note that there is no right or wrong currency pair to trade. While the majors are characterised by having the highest liquidity, the markets fluctuate in many ways, often because of economic news that is specific to a country or currency. As a result, this will be reflected in market pricing. Traders should therefore be in the habit of monitoring overall market conditions to find an opportunity that is best for them and their trading style and strategy.
Additionally, traders should be aware that not all currencies are traded nonstop despite markets being open seven days a week. Allowances should also be made for local public holidays that can put a pause on trading. An economic calendar is useful for helping prepare for scheduled market closures, while live spread tables provide a concise rundown of current market pricing.
Forex currency pairs comparison: Majors vs. Minors vs. Exotics
Major currency pairs
Minor currency pairs
Exotic currency pairs
What is forex trading?
Forex trading is the act of buying and selling currencies. Just as you exchange physical money using a forex transaction on an overseas holiday, forex trading involves buying one currency while simultaneously selling another. A key difference is that forex trading is done specifically to try to generate profit from the exchange.
All forex trades involve two currencies. As the prices of currencies fluctuate in the open market, for example, due to supply and demand factors, traders will speculate that the value of one currency will appreciate or depreciate relative to another. If the trader anticipates the market direction correctly, they can make a profit. If not, they will take a loss. Fundamentally, generating a profit by trading FX is as simple as buying low and selling high, or vice versa.
This multi-directional profit-taking is possible because, unlike traditional investing, forex trading does not involve the purchase or ownership of the underlying currencies. Instead, traders only speculate on price changes using a type of derivative called a Contract for Difference (CFD). The major advantage of CFD trading is that traders can potentially generate a profit by speculating on a falling price, unlike stocks or physical assets, where it is only possible to profit if a price increases above the level you paid for it.
How does forex trading work?
Let's look at a simple example to demonstrate how a forex trade works:
Suppose you believe the euro (EUR) will strengthen against the US dollar (USD); in other words, you think the value of the EUR will increase relative to the USD.
You open a trading account online and decide to buy 10,000 units of the EUR/USD currency pair at the current exchange rate of 1.1000. The total size of your CFD trade position will be:
10,000 EUR x 1.1000 = $11,000
Now that your trade is open, let’s say the EUR/USD exchange rate rises to 1.1200 and you decide to close your trade position. At that point, the difference between the opening and closing exchange rates is 0.0200 (1.1200 – 1.1000). You traded 10,000 units, so your profit calculation looks like this:
0.0200 x 10,000 = $200
Because the value of the EUR has gone up, you make a $200 profit.
However, if the exchange rate had moved against your prediction, you would have incurred a loss. For example, if the price of EUR went down from 1.1000 to 1.0900 (a 0.0100 difference), your loss would be calculated as follows:
0.0100 x 10,000 = $100
These examples show the difference that small fluctuations in pricing can make, so when trading forex, it’s important to only risk what you can afford to lose.
What is the difference between buying and trading forex?
- Buying forex: This usually refers to exchanging one physical currency for another. This could be in cash or digital form (e.g., currency or credit card), but buying forex usually happens when you need to use a foreign currency immediately, such as when taking an overseas holiday where you need to pay for expenses like food or accommodation by using the local currency.
- Trading forex: This involves speculating on the price movements of currency pairs with the intention of profiting from price fluctuations. Forex trading is done through intermediaries, such as online brokers, using derivative products (i.e., CFDs). When trading forex, traders do not physically own the currencies but instead enter into contracts that reflect the price movements of the underlying currency pairs. The aim is to buy a currency pair at a lower price and sell it at a higher price (or vice versa) to generate a profit. Forex trading is conducted electronically on trading platforms, and positions can be opened and closed within seconds or held for longer periods, depending on the trading strategy.
Why trade forex?
The main reason to trade forex is the potential to generate profits by trading currency pairs.
Forex trading is a popular way to start investing with relatively small amounts of capital and combined with the use of leverage, gain exposure to trades of larger value. Additionally, because forex trading is done as a CFD product, traders don’t have to worry about the costs involved in taking ownership of an underlying asset; with FX trades, all you are doing is trading the real-time price movements of the underlying asset in the open market. Note that while leveraged trading offers the potential for higher returns, it can also amplify losses.
The 24-hour FX markets also offer a lot of convenience and flexibility, allowing you to trade during various hours of the day. This can be particularly beneficial for anyone already in full- or part-time employment, as trading can be done outside of normal work hours.
How to trade forex?
Brokers provide a full range of products, tools, and services that allow you to trade currencies online.
To do this, forex traders use free trading software, which is usually provided by the broker, to speculate on the change in the value of one currency relative to another. Unlike traditional stocks, which must increase in value compared to the initial investment, FX traders can speculate on whether a price will rise or fall, so they may have a profit or loss in either market direction.
The FX market can be accessed easily by anyone with an internet connection and a trading account, and trades can be made from anywhere in the world at any time the markets are open. Below is a suggestion for how to start trading forex with an online broker.
Demo accounts can be a great way to practise trading without risking your own money, and once you are ready to transition to live trading, start with a small amount to reduce the risk if the trade goes against you.
- Choose your broker: The key things to look for are regulation, reputation, trading tools and platforms, the range of products offered, and what support and educational resources are available.
- Open an account: You will have a choice of accounts depending on the trading conditions you need (for example, a standard vs. a professional account), but all online forex trading accounts should be free to open. The application process should be straightforward but note that security and fraud protection measures mean a reputable broker will verify your ID before your account can be confirmed. During this process, you should be given access to the trading platform/software.
- Add funds: Once your account has been opened and you have access, make your first deposit so you have money available to trade with. During your account setup, you should be given the option of choosing the currency you prefer to use (e.g., USD, EUR, or GBP).
- Choose a currency pair to trade: After your account has been funded, it is time to consider which forex currency pair(s) you want to trade. All brokers will offer major currencies like USD, EUR, CHF, GBP, AUD, CAD, and more, while some also offer minor or exotic currencies.
- Pick a trading strategy: Before you place your first trade, it is important to consider your goals and how you intend to reach them. Things to consider include the currencies you will choose, the size of your trades, how much you are prepared to risk on a given trade, and whether to use stop-loss and take-profit limits. Technical and fundamental analysis can be beneficial at this point too.
- Place your trade: After deciding your trading strategy, it is time to place your trade. This involves confirming the currency pair you want to trade, choosing how much you want to invest, the direction of the trade (buy or sell), and setting stop-loss and take-profit levels.
- Monitoring: Once your trade has been opened, you will need to check to make sure it is tracking as intended. If the market is not going in your favour, you have the option to close your trade at any time, either to lock in profits or to limit losses.
Technical and fundamental analysis in forex trading
There are two main types of analysis used in trading: technical and fundamental.
- Technical analysis: This is the use of a collection of methods that look for chart patterns that may predict future behaviour. Technical analysis assumes that all the information related to a currency pair is already “priced in.” Therefore, the theory is that if a particular pattern has been repeated in the past, recognising that pattern can help the trader predict the immediate future.
- Fundamental analysis: FX traders use fundamental analysis to consider the underlying economic or policy reasons for a currency’s price fluctuations. The main idea behind the analysis is that if the currency’s underlying economy is predicted to do better compared to other countries, the value of that currency will go up, and vice versa.
What types of charts are used most in forex trading?
There are several types of charts that can be used when analysing the forex market, so deciding which chart to use usually depends on the trading style or type of analysis required. Here are three of the most popular chart types used by forex traders:
- Line charts: Line charts give a clear, simplified view of the current market situation and work best for people who want a quick glimpse of where the market is heading. They simply show the close price at a given period, typically represented by a continuous curved line that connects dots that represent the changes in price over certain intervals of time.
- Bar charts: Bar charts are an upgraded version of the line chart. They offer information on the Open, High, Low and Close prices, so they are also known by the abbreviation ‘OHLC’ chart.
- Candlestick charts: Although candlestick charts look complicated at first, they are actually quite simple to read. Candlesticks represent four main price points within a particular period. This period can usually be set to 1 minute, 5 minutes, 30 minutes, 1 hour, daily, weekly, monthly, etc. The main body of the candle will be coloured green (or it will be empty) if the closing price is higher than the opening price of that period (i.e., the price has increased). If the body is coloured red (or filled in black), the price has decreased within the period. The ability to read candlestick charts and understand candlestick patterns is the first step before using more advanced analysis tools.
Advantages of trading forex
Forex trading offers key advantages when viewed against other forms of investment, like stocks. These include:
- 24-hour trading: The forex market operates around the clock, meaning you can jump in and out of the markets when it suits you. This can be especially helpful for those looking to generate a side income while working another job, particularly with help from trading robots (also known as Expert Advisors, or EAs) which can run trades automatically and reduce the need for manual intervention.
- Leverage: With forex trading, you can take advantage of leverage to control larger value positions with a relatively small amount of capital. However, you must remember that leverage increases both potential profits and losses, so it should be used with caution.
- High liquidity: The forex market’s large size and liquidity ensure you can enter and exit trades quickly at current market prices with a reduced risk of slippage.
- Diversification: There are a lot of different global currency pairs to pick from, which means the forex market provides a wide range of trading opportunities. Whatever the trend and whatever market events are taking place, there is always a currency in play.
- Find opportunities in any market direction: Because forex trading is done through CFDs and you only trade price movements rather than invest in the underlying product, you can trade when the price of a currency pair is going up or down.
- Accessibility: If you have a computer or mobile device and an internet connection, it is likely you can access what you need to start trading forex. Online brokers offer user-friendly trading platforms, educational resources, and demo accounts.
- Learning and development: Learning to trade forex can be a mentally stimulating and rewarding activity. From analysis techniques to market dynamics, the effects of geopolitics on prices, and algorithmic coding, there is always something to learn.
Disadvantages of trading forex
As well as advantages, there are also some potential disadvantages to forex trading, including:
- Volatility: While many forex traders enjoy high volatility due to the potential for fast profits, the downside is that the market can turn against you very quickly. To mitigate this, try using a stop-loss order to limit any losses to a manageable size.
- Leveraged trading: The key thing to remember about leverage is that it amplifies both profits AND losses. Any time you apply leverage, you must consider what would happen if the trade were to go against you.
- Complexity: Although the principles of forex trading are simple, improving your skills requires the use of economic indicators, technical analysis tools, trading platforms, and an understanding of geopolitical events that influence currency prices. This all takes time and effort to learn.
- Emotional challenges: Because there is money at stake, forex trading can evoke strong emotions, especially fear and greed. This can lead to impulsive and irrational decisions, which means emotional discipline is an essential requirement for long-term success.
Remember, forex trading involves risks, and it is crucial to approach it with a disciplined mindset, proper risk management, and continuous learning. Start with small trade sizes, gradually increase your exposure as you gain experience, and only trade what you can afford to lose.
What is the best forex trading strategy?
There are many different forex strategies to follow, each with a different methodology, level of risk, and timeline. Picking the best strategy for forex traders often depends on the individual trader’s goals and abilities.
As traders gain more knowledge of how forex trading works and a greater understanding of the markets, several overarching strategies can be used concurrently across multiple trading products to build a more comprehensive trading profile that is responsive to market conditions and specific objectives.
While no one strategy is guaranteed to work every time, here are some popular forex trading strategies:
- Short-term trading: Short-term trading involves making multiple trades throughout the day to capitalise on short-term price fluctuations. Traders who employ this strategy typically use technical analysis and rely on charts, indicators, and patterns to identify potential entry and exit points.
- Day trading: Day trading is a trading strategy that involves buying and selling financial instruments within the same trading day. Unlike short-term trading, day traders may hold positions for longer periods of time, ranging from a few minutes to several hours.
- Swing trading: Swing trading is a longer-term strategy where a trader may hold positions open for days, weeks, or longer. It is less affected by daily price fluctuations and more concerned with overall trends.
- News trading: This is a strategy in which the trader tries to profit from a market move that has been triggered by a major news event. This could be anything from a scheduled event like a central bank meeting or economic data release, to an unexpected event like a natural disaster or escalating geopolitical tensions.
- Price action trading: Price action trading is a strategy that focuses on making decisions based on the price movements of a certain instrument instead of incorporating technical indicators, which become only a supporting tool.
- Trend trading: These strategies involve identifying trade opportunities in the direction of the trend with the anticipation that the trading instrument will continue to move in its current direction (up or down).
- Range trading: Range traders look for trading instruments that are not trending but are consolidating in a certain range – anything from 20 pips to several hundred pips – where prices are holding within support and resistance lines.
- Position trading: The aim of position trading is to find opportunities from long-term trend moves while ignoring the short-term noise occurring day to day. Traders utilising this type of trading style might hold positions open for weeks, months, and, in rare cases, years!
Risk management in forex
Many professionals and successful traders around the world believe that risk management is one of the principal factors in their trading success. Here are some key considerations for a forex risk management strategy aimed at improving the long-term success of your forex trading.
- Know your risk profile: Are you a big risk-taker? Or do you want to take smaller, more calculated risks? Knowing your own risk profile, or “appetite for risk,” is vital to managing forex trades. Depending on your level of risk-taking, you can adjust your trading strategy accordingly.
- Position sizing: How much you allocate to each trade can have a significant impact on your risk exposure. The bigger your position size, the bigger the potential wins AND losses. The reverse is also true. The smaller the position size, the more manageable the trade is, though it may mean a smaller potential for wins and losses. Understanding appropriate position sizing techniques can go a long way, ensuring you can preserve your trading capital for the long term.
- Stop loss: One of the benefits of modern trading platforms is that they give you the ability to set stop-loss levels. This is a predetermined price at which your trade will automatically close to prevent further losses. Setting a stop loss for each of your trades is one of the simplest and most effective ways of managing trading risks, so use a stop loss to your advantage.
- Leverage: Like a stop loss, you can pre-set or change the level of leverage you want to apply to your forex trades. Leverage allows you to extend a small amount of capital to gain exposure to larger trade positions and magnify profits, but you must be aware that it will also magnify losses.
- Trading psychology: Like knowing your own risk profile, it is also important to know your own trading psychology. This means being honest with yourself when faced with big profits or losses in the markets. Did you suffer a loss, then overtrade trying to make your money back? Did you have a winning streak and then make a bad trade because you got overconfident? If you know your own psychology and understand how you deal with different market conditions, you will be in a great position to prepare for various situations.
- The 1% rule: Some experienced traders use a rule of thumb where they never risk more than 1% of their trading capital. This can be particularly helpful as it means an unforeseen loss will not wipe out your account and you will be able to continue trading.
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This information is not to be construed as a recommendation; or an offer to buy or sell; or the solicitation of an offer to buy or sell any security, financial product, or instrument; or to participate in any trading strategy. It has been prepared without taking your objectives, financial situation, or needs into account. Any references to past performance and forecasts are not reliable indicators of future results. Axi makes no representation and assumes no liability regarding the accuracy and completeness of the content in this publication. Readers should seek their own advice.