What is Forex Trading?
The words “forex trading” provide the definition of this activity. The word FOREX is coined from “FOReign EXchange”.
Forex is another word for foreign currencies. So the definition of “forex trading” is simple: it is the practice of trading currencies, or buying and selling of currencies in order to generate a profit from the activity.
The sole aim of any kind of trading activity anywhere in the world is to be able to sell the product or the asset at a higher price than it was bought for. Trading may also be done by selling an asset for a high price and purchasing that asset once more at a lower price, thus retaining the asset and also having some profit on the transaction.
These two scenarios also play out in the trading of currencies. Currency trading involves two currencies: you have to use one currency to buy another, or you sell one currency to get another. Either way, the trade has to be done at a reference price: a price that is agreeable to both buyer and seller for the transaction to occur. This is known as the rate of exchange or exchange rate.
How does Forex trading work?
You can trade forex in quite a few different ways. You can buy and sell currencies simultaneously, or buy one and sell another at the same time.
In the past, forex transactions were made through brokers but with online trading, you can use derivatives such as CFD trading.
With leveraged products like CFDs, you can open and close trading positions but you do not take ownership of the asset like you do with cryptocurrencies, you simply take a position on that asset and will profit based on the rise or fall of that asset’s value.
What are the Pros and Cons of Forex Trading?
- The forex market is a 24 hour market with well-defined periods of volatility that present trading opportunities.
- The forex market is very liquid, which means there is no shortage of buyers and sellers at any time.
- The forex market is amenable to being traded with automated trading systems.
- Rapid and wide currency movements provide a lot of day trading opportunities.
- News trades have a schedule. Therefore news trades can be planned beforehand.
- The forex market is a virtual market. You can connect to this market from anywhere in the world using an internet-connected device.
- Forex trades do not expire, so there is no fear of sudden liquidation of positions from contract expirations (as is the case in commodity markets).
- There are various ways to trade forex. You can trade spot contracts, forwards and forex options.
- The forex market is very risky and it is very easy to lose money if the trader does not know what he or she is doing.
- Many retail traders are unable to afford to trade with the more transparent ECN models.
- The forex market maker brokerage model presents significant conflicts of interest.
- True mastery of the forex market takes time
Is Forex Trading profitable?
That is definitely a tough question.
Even though some investors claim that they have not made the profits they expected, the forex market trades $5 trillion a day in volume, meaning that some people most definitely make money trading forex, otherwise there would not be so much money going around.
So the answer to the question is yes, it is profitable, the real question is how to trade on it to make money. If you want to give forex trading a try, you may want to take into consideration forex trading simulators first.
5 Forex Trading Tips
Here are a few tips to trade forex:
- Make wise and thought out investments. We recommend making sure that you have a good basic knowledge of how the forex market works and if you are not familiar with something, do not trade with it. Try to carry out the appropriate amount of research before you place a trade and do not rush into anything.
- Diversify your portfolio. Do not put all of your eggs in one basket. It is important that you diversify to minimize your losses as much as possible.
- Develop a trading strategy. There are lots of trading strategies out there. Make sure you search and stick for the one you believe suits you best.
- Use a stop-loss. What we mean by that is that you should have a set closing price on your trade. It will stop you from losing more than you expect.
- Make sure you have forex trading signals to support your trades. These will help you track your trades so that you do not miss buying or selling opportunities and alert you whenever there is a decision to make.
How is the FX Market Structured?
The online forex market does not have a central location. Stock markets usually have a physical exchange.
For instance, the New York Stock Exchange is located in Wall Street, New York. The commodities markets in Chicago have a location. But for the forex market, there is no central location.
Rather, the forex market is virtual and global. Connectivity is maintained via the internet, and this connection is what links all the participants in the online forex market together.
So who are the participants in the online forex market?
- Central Banks
- Institutional traders such as hedge funds, prime brokers, major banks, retail brokers.
- Retail traders.
The image below shows the hierarchy of the forex market.
Some central banks occasionally come to the currency market to buy or sell large quantities of either their own currencies in exchange for other currencies, in an attempt to artificially alter the exchange rates of their currencies.
This process is also known as currency intervention.
The Bank of Japan and the Swiss National Bank have at various times, performed actions that are tantamount to currency interventions. These are not regular events and only occur once in a while. It may even take several years for a central bank to intervene sequentially.
However, central bank interventions are important because their actions can alter the demand-supply dynamics of currencies very quickly. More commonly, central banks will affect interest rates as a consequence of their monetary policy actions.
When central banks intervene in the currency market, they perform large transactions with major banks that constitute the liquidity providers in the interbank market.
The next level of market participation comes from institutional traders.
They constitute 90% of the daily transaction volumes in the market. The 2016 Triennial Survey of the Bank of International Settlements puts daily turnover in the forex market at $5.1 trillion.
That gives us an idea of just how much daily volume comes from the banks, hedge funds, prime brokers and market makers that make up the institutional traders. Institutional traders provide the bulk of market liquidity in the FX market.
At the bottom of the ladder are the retail traders.
They are the individual traders who open accounts with a few hundreds or thousands of dollars with a retail broker. They account for 10% of the market volume.
Due to the very small component of liquidity that they contribute, they cannot participate in the interbank market directly. Therefore, they rely on market makers to generate pricing and trade executions from the liquidity chunks that the market makers have acquired from the interbank market.
Every currency can be abbreviated with 3 alphabets, according to the ISO Standard 4217.
This standard picks the first two letters in a currency acronym from the country of origin and the first letter from the currency name. There are few exceptions (such as the MXN, which is the Mexican Peso. Here, MX comes from Mexico, but the currency name is represented with an N).
Here is a list of currencies, their 3-letter acronyms, and their symbol.
|Great Britain Pound||GBP||£|
|New Zealand Dollar||NZD||NZ$|
|South Africa Rand||ZAR||R|
|South Korea Won||KRW||₩|
|Turkish New Lira||TRY||₺|
|United Arab Emirates Dirham||AED||د.إ|
Currencies: Major, Minor and Exotic
The currency pairs in forex are divided into major, minor and exotic currencies. The major currencies are the most liquid currencies in the forex market. In descending order, these are the top 10 currency pairs by liquidity and traded volumes in the forex market.
- US Dollar
- Japanese Yen
- British Pound
- Australian Dollar
- Swiss Franc
- Canadian Dollar
- Renminbi (Chinese Yuan)
- Swedish Krona
Constituting more than 80% of trading volume in the FX market, the major currency pairs include:
The minor currency pairs (or FX minors) include the following:
The exotic currency pairs are relatively illiquid pairs and carry very wide spreads as a result of their illiquidity.
These pairs usually feature currency pairings of the Swedish, Danish and Norwegian Crowns, the South African Rand, Turkish Lira, and Mexican Peso.
These lists are by no means exhaustive. On your forex platform, you will probably see more minor and exotic currency pairs than are listed here.
Forex Trading Basics
Here are some elements of forex trading. It is important to understand these elements as they play a crucial role in a trader’s ability to trade the market effectively.
- Fundamental Analysis
Exchange rates of forex pairs are wholly determined by forces of demand and supply. These forced are captured in a schedule of economic and political events known as the economic news calendar (also known as Economic Calendar or Forex News Calendar). No other market has such a schedule. The forex news calendar is a compendium of news releases on economic variables or political events which will ultimately sway the sentiment of the major market participants to either buy or sell a currency in exchange for another. Analyzing these news releases in order to determine whether to buy or sell a currency is known as fundamental analysis.
There are various fundamental news releases in an economic calendar. These are divided into low-impact, medium-impact, and high-impact news events. There are many versions of the economic news calendar online, and you will also find this calendar on the MT4 platform. Typically, the impact of a news release can be color-coded or it can be assigned stars according to the level of market impact.
- Low-impact news are assigned a green color, one to two stars and generally do not cause movements in currency pairs.
- Medium-impact news are assigned an amber color, three stars and usually move the currencies very minimally. Usually, these movements are not enough to create trading opportunities.
- High-impact news events are assigned a red color, four to five stars, and usually, create sufficient volatility to cause significant movements in currency pairs. The high-impact news are the tradable news items and are the ones mostly followed by market participants.
Economic Calendar on FXStreet
What are the high impact news events, and why do they sway the sentiment of market participants?
- Interest Rate Decisions
- Gross Domestic Product (GDP)
- Employment Data
- Manufacturing Data
- Inflation data: Producer Price Index and Consumer Price Index (PPI and CPI)
Due to the variation in economic conditions in different countries which produce the currencies being traded, some of the high-impact news releases listed above may be more important in one country and less important in another.
Furthermore, some news releases tend to affect just more than one currency. For instance, GDP and manufacturing data out of China tend to affect the Australian Dollar, as the Australian economy depends on a lot of exports of raw materials to China’s industries.
It should also be noted that what may constitute low or medium impact news for one currency, can actually be of high impact with regards to another currency. Therefore, it is best to search the Economic Calendar to see just which high-impact news are listed for a particular currency pair.
- Technical Analysis
The price information of currency pairs is displayed on the charts. Currencies can, therefore, be analyzed using technical analysis. Technical analysis involves the use of patterns, candlesticks, wave patterns and indicators, all in a bid to forecast future price action and to make timely trade entries.
- Leverage/Margin Requirements
In order to ensure that traders can afford to set up forex trades with far less money, the concept of leverage was introduced. Leverage enables traders to setup trades of a higher amount than their capital can ordinarily carry. In forex leverage, the trader contributes a small portion of the required capital to collateralize the trade. This is known as the margin. The broker provides the rest of the capital.
Leverage in forex stretches from 1:2 and is capped at 1:20 for FX minors and 1:30 for FX majors on the trading platforms of UK and EU platforms. Australian brokers still offer a leverage cap of 1:500. Brokers in other parts of the world offer varying caps on leverage, with the most popular being 1:500.
Currency movements are very small, usually in the order of 4 or 5 decimal places. So a change in value in a currency pair is usually in the order of 1 pip, or 0.0001 points. If a currency pair were to change the value by 25 pips, this would only be a move of 0.0025 points, which is very small indeed.
In order to magnify the monetary value of the change in the exchange rate, large volumes of trade must be performed. In forex, trade volumes are measured in lots, with a Standard Lot being equivalent to $100,000. If you were to use $100,000 to trade a change in 25 pips, this would equate to a change of 100,000 X 0.0025 = $250. The question is: how many retail traders can afford to $100,000 to trade a typical forex position? There are not many who can afford this.
Margin requirement = cost of the trade volume/leverage
To use our previous example, a leverage of 1:30 will mean that the trade only requires 100,000/30 or $3,333 to trade a Standard Lot. For a mini-lot which is 1/10th of a Standard Lot, the requirement is only $333. Even with leverage, the full value of any profit or loss for a trade is settled on the trader’s account.
Forex trades on retail trading platforms do not attract commissions. Rather, each trade is charged a spread once the position is opened, which is the difference between the bid and ask prices in a currency quote. Forex trades on institutional trading platforms, or on ECN/non-dealing desk platforms are charged both spreads and commissions. Commissions are usually charged as a flat rate per Standard Lot on both the trade entry and exit.
- Price Quotes
Forex exchange rates are quoted in pairs. A price quote has a price on the left, known as the Bid price, and a price on the right known as the Ask or offer price. Long trades are fulfilled at the asking price, and short trades are fulfilled at the bid price.
If GBP/USD is quoted at 1.30220/1.30231, the bid price is on the left (1.30220) and the asking price is on the right (1.30231).
- Trading Volumes
Sizes of forex positions are measured in lots. A Standard Lot is worth $100,000. It is the standard reference for position sizing in the forex. 1 lot can be subdivided into mini-lots (0.1 to 0.99 lots), and micro-lots (0.01 to 0.099 lots).
- Monetary Value Per Pip
A PIP stands for Percentage Interest Point. This is the smallest unit of measurement of a change in exchange rates for a currency pair. The monetary value of a Standard Lot of a currency pair is $10 per pip. How is this calculated?
- 1 pip = 0.0001 points.
- 1 Standard Lot = 100,000 units of a currency.
- Monetary value per pip = 100,000 X 0.0001 = 10 units.
Using the same calculation, 1 mini-lot is worth $1 per pip, and 1 micro-lot is worth 10 cents per pip.
How Forex Trading Works
As defined above, forex trading is the buying or selling of one currency against another, in an attempt to profit from the change in the initial rate at which the two currencies were exchanged. This is the reason for currencies being traded in pairs. Profiting from forex can occur from price movements in both directions. If you are buying, you profit when prices go up. If you are selling your profit when currency rates drop. This is how both trading scenarios work.
1. Profiting from an Increase in Exchange Rates
A forex trader profits from an increase in the exchange rate if the base currency (i.e. the currency which is listed on the left side in a currency pair) is bought.
In other words, if the trader is buying the GBP/USD, or going long on the GBP/USD, a profit will be made if the rate at which the transaction occurred goes up and the trade is exited at the new price.
- For example, if Trader Kobe feels that the exchange rate on the GBP/USD will go up, he would have to buy or “go long” on the GBP/USD. He buys 2,500 British Pounds at an exchange rate of 1.3000. He will, therefore, spend $3,250 to acquire 2,500 GBP.
- In the forex trading world, this trade would be to go long on the GBP/USD at 1.3000.
- In a few hours, the rate rises from 1.3000 to 1.3120. To get a profit, Kobe closes the trade by selling his 2,500 British Pounds at the new rate, getting $3,280 back.
- Kobe’s profit would be $3,280 – $3,250, which is $30.
In the real world of forex, trades are leveraged. If Kobe decides to use a leverage of 1:10 for this trade, this means he would only need a tenth of the total cost of the trade ($2,500). Therefore the cost to Kobe would be 1/100 of $2,500, which is $250. So Kobe would only need to put down $250 in margin for the trade.
2. Profiting from a Decrease in Exchange Rates
A trader can also profit if exchange rates fall. To do this, the trader would have to sell or “go short” on the currency that the trader believes will weaken in value. Let us illustrate this using another trade by Kobe.
- This time, Kobe feels that the US Dollar will weaken relative to the Japanese Yen and decides to sell S13,000 for Japanese Yen at a rate of 100 Yen to 1 US Dollar. He gets 1.3 million Yen in this transaction.
- In 2 days, the exchange rate is now 98.20 Yen to the US Dollar. Kobe decides to use his Yen to re-acquire the US Dollar. He will get $13, 238 in return using this new exchange rate.
- Kobe’s profit will be $13, 238 – $13,000 = $238.
This is how money is made in the forex market. You can buy an undervalued currency and gain from it when it increases in value, or you can sell an overvalued currency and profit when you reacquire it at an undervalued price.
Practical forex trading on a forex platform will have to account for the following:
- A spread is paid to the broker for the currency pair being traded. Different currency pairs have different spreads.
- The trader will have to choose from various leverage provisions.
- The trader must use an appropriate trade volume, and this trade volume must conform to risk management principles.
Types of Forex Brokers
There are two categories of forex brokers in the forex market. You’ll find a more detailed explanation in our article Best Forex Brokers for 2020: Comparison of the Top 7 Forex Brokers.
a) Market Makers/Dealing Desk (DD) Brokers:
They operate the dealing desk model. This model generates prices and offers trade execution from the dealing desk department. This is where the bulk of retail forex trading is done. Market makers bridge the liquidity gap between retail traders and the interbank market. These brokers offer the popular MT4 and MT5 trading platforms, as well as other platforms that cater to the retail end of the market.
b) Non-Dealing Desk (NDD) Brokers:
This is the institutional-style brokerage model where pricing and execution of trades are handled by the liquidity providers in the interbank FX market. There is no dealing desk intervention. Liquidity needs mean that only traders with a lot of money to spare can open accounts with NDD brokers. These brokers offer complex trading platforms, most of which are proprietary in nature and have additional features that go beyond trading alone.
What You Need to Trade Forex
To trade forex, you need the following:
- Access to the virtual forex market. This is done using a trading platform provided by a broker. You must open an account and verify your identity and residence by submitting an international passport, or drivers’ license (certain countries only), as well as a utility bill/bank statement.
- You must have a funded trading account. You will need trading capital with which to provide margin to conduct your forex trades. This requires access to a payment method that is acceptable to your broker
- You must have some level of training to understand how to trade the forex market. Many brokers now offer introductory courses on forex trading for beginners.
- You must have an internet-connected trading station (computer, smartphone or tablet device) with which to buy and sell currencies on the trading platform.
How to Trade Forex - Step by Step Forex Trading Tutorial
Let us assume that you want to buy the GBP/USD, after performing your analysis and you feel it will rise in value. How do you trade this on the most popular retail trading platform (MT4)?
- Click on “New Order”, or you press the F9 button on your computer. Alternatively, you can also right-click on the chart of the currency pair you want to trade, and click on “New Order”.
- If you want to buy at market price, simply enter the parameters you want for your trade such as the lot size (i.e. volume), the Stop Loss, Take Profit, etc. For pending orders, change the Order Type to “Pending Order”, and select the type of pending order to be used.
- Click on the “Sell by Market” or “Buy by Market” tabs to execute the market orders, or click on “Place” to execute your pending orders.
In this example, a sell order has been placed. If the price of the GBP falls relative to the USD, a profit will be made. If the price rises relative to the market price and the stop-loss is hit, the trade ends in a loss.
Best Forex Trading Courses
If you are interested in some forex trading training, there are plenty of video trading courses.
A good forex trading course should include:
- The best forex trading platform to use and how to get the most out of it
- Basic charting skills including using support & resistance with Fibonacci retracement levels
- How to find the best entry point, stop-losses and take profit levels
- Explanation of what using leverage means and the risks that come with it
- How to scale into a position
- Understanding different time-frames on charts and making short term vs long term trades
5 Forex Trading books you need to read
We've put together a brief list of books we recommend reading if you are interested in getting into the forex trading industry. They are definitely great reads that all kinds of users can benefit from to gain some insight into the world of forex trading.
- "Currency Forecasting" by Michael Rosenberg
- "How to make a living trading Foreign Exchange" by Courtney Smith
- "Trading in the Zone" by Mark Douglas
- "Reminiscences of a stock operator" by Edwin Lefevre
- "The Candlestick Course" by Steve Nison
Forex trading is the buying and selling of currencies in order to generate a profit from the exchange rate differentials that occur between the currencies in question, as they are subjected to the vagaries of market forces. The number of forex pairs you will find on a trading platform differs from broker to broker. However, we can comfortably state that there are no less than 50 currency pairs in the forex market. Forex trades do not expire. They will remain open as long as you want, provided there is enough margin to maintain the running position and provided your active trade does not hit your stop loss or take profit targets. The active trades will also rollover at the close of the trading day by 5 pm EST. The MT4 platform is loaded with charts and all kinds of tools that are commonly used for technical analysis. Some MT4 brokers also offer their clients access to a technical analysis service from Trading Central. On EU/UK forex platforms, you can trade major forex pairs at a leverage of 1:30, and minor forex pairs at a leverage cap of 1:20. International brokers located outside the UK and EU provide forex leverage that can be as high as 1:500. The MT4 platform is suitably built for use with a forex Virtual Private Server (VPS). Some MT4 brokers also provide free access to a forex VPS for traders who have funded live accounts. All active positions will remain open and will be rolled over to the next trading day. You can use a forex robot to trade on brokers that offer the MT4 to their clients. Traders who operate STP and ECN accounts, investment banks, high net-worth investors, hedge funds and central banks, buy and sell currencies at the interbank market. This is also where the liquidity providers are found. Liquidity providers in the forex interbank market include: Technically Speaking, Yes.... you can get rich by trading any type of asset class. What you need to keep into consideration is the fact that trading is not a make a rich scheme, it takes time and hard work to learn to trade profitably. With unemployment levels hitting alarming rates in many parts of the world, many have turned their eyes towards modern ways to make a living and Forex trading has been at the top of the list due to the high returns and lavish lifestyle marketed by the so-called forex "Gurus". If you are getting into trading to simply make a quick buck then it is not going to be anywhere else better than a casino, you are simply not going to have an edge in the market and the odds of losing money are against you. On the other hand, if you follow the right track and focus on truly learning how to trade and read the markets, you could even become a billionaire over time. This is another question where technically you could start trading with a small account of $100 in most European Brokers. While on paper you can make it grow from there and turn it into a monster 7 figures account over time, it is not as simple as it looks and even with the smallest trading size, everything will be against you. This is a numbers game where you know your edge will deliver results 70% of the time and with a high-risk reward ratio, you are certain that you will be able to make money. The real answer here is how much money, and that will depend on your sizing and your account size. On average a healthy forex account should be at least $5,000 allowing space for the trades to play and work for you. Keep in mind that you can learn the basics form forex trading without the necessity of having a live account, you can easily learn the basics from a demo and slowly start applying everything in the practice.
Forex trading is the buying and selling of currencies in order to generate a profit from the exchange rate differentials that occur between the currencies in question, as they are subjected to the vagaries of market forces.
The number of forex pairs you will find on a trading platform differs from broker to broker. However, we can comfortably state that there are no less than 50 currency pairs in the forex market.
Forex trades do not expire. They will remain open as long as you want, provided there is enough margin to maintain the running position and provided your active trade does not hit your stop loss or take profit targets. The active trades will also rollover at the close of the trading day by 5 pm EST.
The MT4 platform is loaded with charts and all kinds of tools that are commonly used for technical analysis. Some MT4 brokers also offer their clients access to a technical analysis service from Trading Central.
On EU/UK forex platforms, you can trade major forex pairs at a leverage of 1:30, and minor forex pairs at a leverage cap of 1:20. International brokers located outside the UK and EU provide forex leverage that can be as high as 1:500.
The MT4 platform is suitably built for use with a forex Virtual Private Server (VPS). Some MT4 brokers also provide free access to a forex VPS for traders who have funded live accounts.
All active positions will remain open and will be rolled over to the next trading day.
You can use a forex robot to trade on brokers that offer the MT4 to their clients.
Traders who operate STP and ECN accounts, investment banks, high net-worth investors, hedge funds and central banks, buy and sell currencies at the interbank market. This is also where the liquidity providers are found.
Liquidity providers in the forex interbank market include:
Technically Speaking, Yes.... you can get rich by trading any type of asset class. What you need to keep into consideration is the fact that trading is not a make a rich scheme, it takes time and hard work to learn to trade profitably.
With unemployment levels hitting alarming rates in many parts of the world, many have turned their eyes towards modern ways to make a living and Forex trading has been at the top of the list due to the high returns and lavish lifestyle marketed by the so-called forex "Gurus".
If you are getting into trading to simply make a quick buck then it is not going to be anywhere else better than a casino, you are simply not going to have an edge in the market and the odds of losing money are against you. On the other hand, if you follow the right track and focus on truly learning how to trade and read the markets, you could even become a billionaire over time.
This is another question where technically you could start trading with a small account of $100 in most European Brokers. While on paper you can make it grow from there and turn it into a monster 7 figures account over time, it is not as simple as it looks and even with the smallest trading size, everything will be against you.
This is a numbers game where you know your edge will deliver results 70% of the time and with a high-risk reward ratio, you are certain that you will be able to make money. The real answer here is how much money, and that will depend on your sizing and your account size. On average a healthy forex account should be at least $5,000 allowing space for the trades to play and work for you.
Keep in mind that you can learn the basics form forex trading without the necessity of having a live account, you can easily learn the basics from a demo and slowly start applying everything in the practice.