What is forex trading and how can you trade it?

What is forex trading?

Forex trading is a form of trading based on the Foreign Exchange. It’s a global marketplace in which traders exchange national currencies against each other, and is one of the largest and most fluid asset markets in the world.

There is no central marketplace for forex - instead all trading is done online, with main markets being open 24 hours a day, five days a week. Major centres include Hong Kong, London, Frankfurt, New York and Tokyo. Due to its global nature, the forex market is highly dynamic, with prices constantly fluctuating based on economic indicators, geopolitical events, and market sentiment.

How does forex trading work?

The Forex market is the world’s only trade that takes place 24 hours a day throughout Monday to Friday. Historically it was run by large banks and businesses, but in recent years it has become more accessible to traders and investors of all sizes.

Forex trading is a trade on the changing values of pairs of currencies, for example Euros and US Dollars (EUR/USD). If you think the Euro will increase in value against the USD, you’d buy Euros with dollars. If the value of Euros then does increase as you predicted, you could sell your Euros back and get more Dollars than you initially invested.

This is what’s known as speculative trading.

The forex market is also used for hedging. This is when people and businesses use the market to protect themselves from currency movements, insuring themselves against losses by investing their money in other, more favourable currencies. This is a key part of many international businesses today, and helps ensure financial stability.

There are three key areas to the forex market: margin, leverage and order type.

The margin is the amount of money the trader needs to start a trade.

The leverage is borrowed money in order to begin a trade.

And the order type is the type of trade you’re wanting to make, usually consisting of market, limit entry, stop entry, stop loss, or trailing stop.

What moves the forex market?

Because of its global nature, there are many things that can impact the value of international currencies, thus affecting your forex investments. Economic factors such as interest rates, inflation and economic growth can have a significant impact on currency prices, while away from finances, aspects like political uncertainty, international affairs and - as was the case in 2020 - viral outbreaks can all play major roles.

Base rates, as defined by central banks, can play a huge role in how the market moves, as they will ultimately impact the value of the currency. Exchange rates can also fluctuate depending on a country’s economic outlook, which will affect the value of the currency you may be trading in.

It’s also always worth keeping an eye on international news. Alarming headlines, political unrest and even prolonged periods of bad weather can have a negative impact on a currency’s value, while low sentiment can lead to traders selling their currency and affecting the market rate.

How can I start trading forex?

To start forex trading, you need to get a few things in a row.

1. Choose your desired Forex broker.
2. Research currencies and potential opportunities.
3. Open a Forex trading account. To do this you’ll need to verify your identity and add your first funds for trading.
4. Set up your first forex trade.

What are different strategies for trading forex?

Day trading

Day trading involves buying and selling financial instruments within the same trading day, with all positions closing before the market closes. Day traders typically engage in multiple trades per day, aiming to profit from short-term price fluctuations in highly liquid markets. This approach can be highly volatile and is best suited for those who can handle rapid price changes and have a solid understanding of market dynamics and risk management.

Swing trading

Swing trading is a mid-term trading strategy where positions are held for several days to weeks. Traders aim to profit from price changes by identifying and capitalising on 'swing highs' and 'swing lows' within a trend. This method relies on technical analysis to capture short- to medium-term market movements, and is best suited for those who prefer less frequent trading but still want to actively manage their positions.

Position trading

Forex position trading focuses on long-term changes in the market. Traders can hold positions for weeks, months, or even years, aiming to benefit from significant price movements over that prolonged period. This approach relies on fundamental analysis to identify trends and economic factors that will impact the market over time, making it suitable for those who are patient and can tolerate extended periods without immediate returns.

Carry trading

A carry trade involves borrowing from a lower interest currency pair to fund the purchase of a currency pair with a higher interest rate, with the aim to profit from the difference in interest rates between the two currencies.

Scalping

Scalping involves a trader ‘skimming’ small profits on a regular basis. This is done by going in and out of positions several times a day, and will see currencies traders based on a set of real-time analysis.

Trend trading

Trend trading is a strategy that involves profiting from gains by looking at an asset's momentum. In short, if the market is rising, you would take a long position, while you’d go for a short position if it was falling. Traders can split trends up into primary and secondary movements, with the primary trend focused on long-term, overarching movements, and the secondary trend aiming to profit from short-term fluctuations.

Get to grips with the key forex terminology

As with any kind of trading, there is a lot of specific language that it helps you understand. Many first-time traders can feel overwhelmed by all the new phrases, so getting to grips with these will help you start your forex trading journey confidently.

What is leverage in forex?

Leverage in forex trading allows you to control a larger position in the market with a smaller amount of capital. Typically, this involves borrowing funds from a broker. The amount of leverage provided dictates how much of a currency you can buy or sell, amplifying both potential profits and potential losses.

What is a forex pair?

A Forex pair represents the relative value between two currencies being traded. For instance, when trading the British Pound (GBP) against the Hong Kong Dollar (HKD), the Forex pair denotes the exchange rate between these two currencies. This exchange rate indicates how much one currency is worth in terms of the other.

What is a PIP in forex?

A PIP, or "percentage in point", is a standard unit of measurement representing the smallest whole unit change in the exchange rate of a currency pair. It quantifies the minimal price movement in the exchange rate, serving as a fundamental concept in forex trading.

What are forex base and quote currencies?

In a currency pair, the base currency is the first currency listed, while the quote currency is the second. The base currency represents the value being measured, and the quote currency denotes how much of the second currency is needed to purchase one unit of the base currency.

What is a lot in forex trading?

In forex, a standard lot size is equal to 100,000 units of the currency you’re trading in. So for example, if you bought a currency with an exchange rate of $1.052, one lot would be equal to 105,200 units.

In forex trading, a standard lot size represents 100,000 units of the base currency. For instance, if you purchase a currency with an exchange rate of $1.052, one standard lot would be equivalent to 105,200 units of the currency. Understanding lot sizes is essential for effective position sizing and risk management in forex trading.

What is a position in forex trading?

A position in forex trading refers to the amount of a particular currency pair that a trader owns or has committed to buying or selling. It encompasses three key elements: the currency pair, the position size and the position direction; long or short.

• A long position in forex: A long position is initiated when a trader expects the value of the currency pair to appreciate. The trader buys the currency pair and holds it, aiming to sell it at a higher price to profit from the increase in value.
• A short position in forex: A short position is taken when a trader anticipates a decline in the value of the currency pair. The trader sells the currency pair with the intention of buying it back at a lower price, thus profiting from the difference between the selling and buying prices.

Understanding these concepts is fundamental to effective forex trading, as these form the basis of strategic decision-making and risk management in the market.

What are the benefits of forex trading?

Forex trading is the largest financial market in the world, providing traders with opportunities for growth. It operates 24 hours a day, five days a week, allowing you to trade around the clock and capitalise on fluctuating currency values.

Here are some key benefits of forex trading:

• High Liquidity: The forex market's high liquidity enables quick execution of trades and the ability to capitalise on market movements.
• Flexibility: Traders can either opt for long positions, where they think a market will rise, or short positions, where they think a market will fall.
• Diverse Trading Options: A wide range of currency pairs is available, offering numerous trading opportunities.
• Hedging Opportunities: Forex trading allows for hedging, which can help protect substantial assets or business interests from adverse currency movements.
• Leverage: Utilise leverage to make your money go further by opening larger positions with a smaller initial investment, potentially increasing your profit opportunities.

Forex trading's flexibility, liquidity, and range of options make it an attractive market for traders looking to maximise their investments.

What are the risks of forex trading?

As with any market trading, forex trading carries significant risks. Here are key risks to consider before entering the forex market:

• Leverage Risk: Price fluctuations can trigger margin calls, requiring additional funds to cover losses. In volatile markets, this can lead to substantial losses.
• Interest Rate Risk: Changes in interest rates can significantly affect currency values, potentially resulting in investments selling for much less than anticipated.
• Transaction Risk: The 24-hour nature of forex trading means currencies can be traded at different times and prices, increasing the risk due to time differences.
• Country Risk: In countries with fixed exchange rates, the inability of a central bank to maintain these rates can lead to currency crises and rapid devaluation.

Other forex trading terms you should know

Bid: The bid price is how much a Forex Trader is willing to sell their currency for.

Ask: The Ask price is how much a Forex broker is willing to sell the base currency for,enabling you to trade.

• Margin: The margin is the required amount needed to open a trade and maintain a position. This is not a transactional cost - instead it’s more like a security deposit to keep the trade open.
• Exchange rates: The exchange rate is the value at which one currency can be exchanged for another. Most Forex exchange rates are defined as floating, and can rise or fall based on supply and demand in the market
• Spread: A forex spread is the difference between the bid price and the ask price of a currency pair. This is usually measured in pips.
• Major pairs: Major pairs include the US dollar and are the most frequently traded. Examples are EUR/USD, USD/JPY, GBP/USD, USD/CAD, USD/CHF, AUD/USD, and NZD/USD.
• Exotic pairs: Exotic forex pairs include currencies from emerging markets featuring a much higher spread and lower liquidity
• Stop-limit order: This order type minimises risk when buying and selling currencies. It activates when your trade reaches a predefined amount.
• Stop-loss order: This order type automatically executes a trade to buy or sell a currency when it reaches a specified price, helping to limit potential losses.