What is forex trading and how does it work?

Updated by: Maria Stylianou | Senior Copywriter

Forex trading, or foreign exchange trading, involves speculating on changes in exchange rates between currency pairs in the global foreign exchange market. You can take positions on hundreds of currency pairs, including EUR/USD, GBP/USD and USD/JPY, aiming to profit from price movements. 

Most retail brokers, including Pepperstone, allow you to trade forex through CFDs (contracts for difference), enabling you to speculate on the price movements of currency pairs without owning the underlying currencies.

Forex trading also typically involves the use of leverage, allowing you to gain exposure to a larger position with a smaller initial outlay. While leverage can increase potential gains, it can also amplify losses.

When trading forex, you take a view on whether an exchange rate will rise or fall. If you expect it to rise, you place a buy (long) order. If you expect it to fall, you place a sell (short) order. You profit when the market moves in your favour and lose when it moves in the opposite direction.

You can monitor market movements and manage your exposure using a range of risk-management tools and order types. To help identify trading opportunities, you can use technical analysis, such as charts and indicators, alongside fundamental analysis, including economic data releases, central bank decisions and market news.

A forex pair is the quotation of two currencies in the foreign exchange market, representing their relative fair value. It is made up of a base and a quote currency.

Base and quote currencies

In a forex pair, the base currency is the first currency listed and is the one being bought or sold. The quote currency is the second currency and represents how much of it is needed to purchase one unit of the base currency.

For example, in the EUR/USD pair, EUR is the base currency, and USD is the quote currency. If the EUR/USD pair is quoted at 1.1100, it means 1 EUR can be exchanged for 1.11 USD. In USD/JPY, the base currency is USD, and the quote currency is JPY. If the pair is quoted at 144.00, it means 1 USD can be exchanged for 144.00 JPY.

Major, minor and exotic pairs

Currency pairs are generally grouped into three categories, depending on how widely they’re traded and how liquid they are.

Major pairs: The most heavily traded pairs, each pairing the US dollar with another leading global currency.

EUR/USD – euro/US dollar

USD/JPY – US dollar/Japanese yen

GBP/USD – British pound/US dollar

USD/CHF – US dollar/Swiss franc

USD/CAD – US dollar/Canadian dollar

AUD/USD – Australian dollar/US dollar

NZD/USD – New Zealand dollar/US dollar

Minor pairs: Pairs that combine two major currencies, excluding the US dollar.

EUR/GBP: euro/British pound

EUR/AUD: euro/Australian dollar

GBP/JPY: British pound/Japanese yen

EUR/JPY: euro/Japanese yen

NZD/JPY: New Zealand dollar/Japanese yen

GBP/CAD: British pound/Canadian dollar

CHF/JPY: Swiss franc/Japanese yen

AUD/JPY: Australian dollar/Japanese yen

Exotic pairs: Pairs that combine a major currency with one from a smaller or developing economy. These typically come with wider spreads and lower liquidity, so costs and slippage can be higher.

USD/TRY – US dollar/Turkish lira

USD/ZAR – US dollar/South African rand

EUR/TRY – euro/Turkish lira

USD/MXN – US dollar/Mexican peso

USD/SGD – US dollar/Singapore dollar

USD/THB – US dollar/Thai baht

A pip, or ‘percentage in point’ is the smallest unit of price movement in forex trading. It typically represents the fourth decimal place in a currency pair's quote (0.0001). For example, in the EUR/USD pair, a movement from 1.1050 to 1.1051 equals one pip. Pips help measure profit and loss and standardise changes in currency values.

• If the EUR/USD moves from 1.1075 to 1.1085, that’s an increase of 10 pips.
• If the EUR/USD moves from 1.1085 to 1.1075, that’s a decrease of 10 pips.

The exception to this rule is the Japanese Yen (JPY), which is quoted to two decimal points:

• If the USD/JPY moves from 144.20 to 144.40, that’s an increase of 20 pips.
• If the USD/JPY moves from 144.05 to 143.95, that’s a decrease of 10 pips.

In forex trading, a lot is a standardised unit of measurement for the amount of currency being traded. There are four main types of lots:

• Standard lot: A standard lot represents 100,000 units of the base currency. For example, if you buy EUR/USD at an exchange rate of 1.1076, one standard lot would be worth $110,760 (100,000 × 1.1076).
• Mini lot: A mini lot represents 10,000 units of the base currency. Using the same EUR/USD example, a mini lot would be worth $11,076 (10,000 × 1.1076).
• Micro lot: A micro lot represents 1,000 units of the base currency. In this case, one micro lot for EUR/USD would be worth $1,107.60 (1,000 × 1.1076).
• Nano lot: A nano lot represents 100 units of the base currency. For EUR/USD, one nano lot would be worth $110.76 (100 × 1.1076). This size is often used by beginner traders or those managing very small accounts.

How lot sizes affects pip value

Using a 100,000-unit (standard) lot, here’s how lot size affects pip value:

• USD/JPY at an exchange rate of 144.90: (0.01 / 144.90) x 100,000 = $6.90 per pip
• USD/CHF at an exchange rate of 1.1791: (0.0001 / 1.1791 x 100,000 = $8.48 per pip
• In cases where the U.S. dollar is not quoted first, the formula is slightly different:
• EUR/USD at an exchange rate of 1.1080: (0.0001 / 1.1080) x 100,000 = 9.03 x 1.1080 = $9.9999 rounded up will be $10 per pip.
• GBP/USD at an exchange rate of 1.3170: (0.0001 / 1.3170) x 100,000 = 7.59 x 1.3170 = $9.9999, rounded up will be $10 per pip.

The example below is for illustration purposes only and it’s not a trading recommendation. It excludes leverage, spreads, commission and overnight funding charges.  

Suppose you expect the euro to strengthen against the US dollar, so you buy (go long on) EUR/USD.  

You open a position of 1 mini lot (10,000 units) at 1.1000 – a position size of $11,000 (10,000 × 1.1000).  

EUR/USD rises to 1.1050 – a 50-pip move in your favour. For a EUR/USD mini lot, each pip is worth approximately $1, so that’s a gross profit of roughly $50.  

If EUR/USD had instead fallen to 1.0950 – a 50-pip move against you – you’d face a loss of a similar size.

The forex market operates 24 hours a day, five days a week across four major trading sessions.

• Sydney: 21:00-06:00 UTC
• Tokyo: 00:00-09:00 UTC
• London: 07:00-16:00 UTC
• New York: 12:00-21:00 UTC

Note: All times are shown in Coordinated Universal Time (UTC). Session times may vary with daylight saving changes.

Volatility and liquidity shift with each session, so understanding them can help you find hours that suit your trading style.

• Sydney sets an early tone for the week and overlaps briefly with Tokyo.
• Tokyo overlaps with the start of London.
• London – typically the busiest single session – overlaps with New York to close the day. The London–New York overlap is generally the most active window, since it brings together the two largest financial centres.

Trading activity is often highest when major sessions overlap, particularly during the London-New York overlap. Higher liquidity can contribute to tighter spreads, although increased market activity may also lead to greater price volatility and a heightened risk of losses.

• 24-hour market: Operates around the clock, allowing trading at any time during weekdays. 
• High liquidity: Major currency pairs are highly liquid, making it easy to enter and exit positions. The Bank for International Settlements (BIS) Triennial Survey reported that global foreign exchange trading reached an average of $9.6 trillion per day in April 2025, making it the most liquid financial market in the world. This allows for easy trade execution and minimal price slippage. 
• Leverage: Allows control of larger positions with a smaller amount of capital. However, it increases both profits and losses. 
• Diverse opportunities: Access to global markets and a variety of currency pairs (major, minor and exotic) provides numerous trading opportunities: 
• Low transaction costs: Typically, forex trading involves low or no commission fees, with costs embedded within the bid/ask spread. 
• Accessibility: Many online platforms like TradingView offer easy access and user-friendly interfaces for forex traders of all levels.

• Leverage: High leverage can amplify losses, potentially exceeding your initial investments. 
• Market volatility: Sudden price movements can lead to significant losses, especially in volatile markets. 
• Counterparty exposure: Risk of the broker defaulting or facing technical issues during fast, unusually volatile markets  
• Economic events: Currency values are affected by global economic events, which can lead to unpredictable fluctuations. 
• Interest rates: Changes in interest rates by central banks can impact currency prices and market stability. 
• Geopolitical developments: Geopolitical events or instability can cause sudden and significant market movements. 
• Overtrading: Excessive trading or emotional decisions can lead to substantial losses. 

Effective risk management and a well-researched trading strategy are essential to mitigate these risks. 

The forex market is influenced by several key factors: 

• Economic indicators: Reports such as GDP, employment data, inflation rates, and manufacturing output impact currency values. Strong economic performance typically strengthens a currency. 
• Central bank policies / interest rates: Actions and statements by central banks, including quantitative easing or monetary tightening, impact currency value. Higher interest rates typically attract foreign investment, boosting a currency's value, while lower rates can weaken it. 
• Geopolitical events: Political instability, elections, trade and geopolitical tensions can cause significant market movements. 
• Market sentiment: Traders’ perceptions and psychological factors, including market rumours and news, influence currency movements. 
• Trade and capital flows: Changes in trade balances and foreign investment levels can affect currency supply and demand. A trade surplus increases demand for a nation's currency, therefore strengthening it, while a deficit weakens it. Similarly, high foreign investment inflows boost a currency's value, whereas outflows can lead to depreciation. 
• Global events: Natural disasters, pandemics and other major events can create sharp volatility, often pushing investors towards perceived safe-haven currencies like the US dollar and Japanese yen.

Before opening a forex trading account, learn the basics of the market and practise on a demo account. Once you're confident trading in a live environment, follow these steps:

1. Choose a reliable broker with good reviews, low spreads and strong customer support.
2. Open a trading account, choosing the account type that suits your needs.
3. Deposit funds you’re comfortable risking.
4. Download a trading platform, such as MetaTrader 4 or 5, to execute trades and analyse the market.
5. Create a trading plan based on your financial goals, trading experience, available time and risk appetite.
6. Monitor and review your positions, stay informed via market news, and adapt your strategy as needed.

Once you understand the basics of forex trading, you can open a Pepperstone CFD account and start speculating on the price movements of currency pairs.

1. Sign up with your email address (or via Apple, Google or Facebook) and confirm your account. You can access a free demo account at this stage.
2. Complete a short questionnaire on your financial situation and trading experience.
3. Upload the required documents (proof of identification and proof of residence) to get verified as a client.
4. Choose your account type (CFD Standard or Razor) and select your preferred platform like MT4, MT5, cTrader, TradingView or the Pepperstone platform.
5. Fund your account with your desired amount, using one of our funding methods.