How Does Forex Trading Works: Beginners Guide To Forex Trading 

The foreign exchange market or Forex where investors trade currencies is without a doubt the biggest financial market. The trades that happen in the Forex market affect everything around the world from the amount you pay for fuel in Las Vegas to the price of headphones imported from the UK.

Although Forex trading is completely legal, the industry is rife with bad actors and scams. As an investor, you should always do due diligence before you venture into the global financial market.

What Is Forex Trading?

Forex trading is the real-time act of buying one currency and selling another. The combination of the currency sold and the one bought makes up what’s commonly called a “currency pair”. These currencies are traded in pairs and every currency in the pair is usually represented by a three-letter code such as JPY for Japanese Yen. As you can see, the first two letters in the code represent the country, while the third represents the currency.

The currencies are traded in a foreign exchange market, a marketplace that is open 24 hours every day from Monday through Friday. Forex trading is usually conducted over the counter, which means there is no physical exchange. It’s also important to note that the entire market is controlled by a global network of banks and leading financial institutions.

Most of the trade activity in the foreign exchange market takes place between institutional traders. These are the people who work for multinational corporations, fund managers, and banks. The Forex traders don’t intend to take physical possession of the currencies, but could just be hedging against or speculating about future fluctuations of the exchange rate.

For example, a trader can buy Euros (and sell US Dollars), if he strongly believes the Euro will strengthen in value and as a result might be able to purchase more Dollars in the future. On the other hand, a company based in the United States, but with European operations can use the foreign exchange market as a hedge in case the Dollar weakens, which results in the value of the company’s income falling.

How Currencies Are Traded

As mentioned earlier, currencies are assigned a unique three-letter code. Although there are over 170 currencies in the world, the US Dollar is involved in most of the Forex trades. Therefore, it’s very important to know its code, USD. Accepted in about 19 nations across the European Union, the Euro is the second most popular currency in the foreign exchange market, its code is EUR.

Other major currencies traded in the Forex market include:

  • New Zealand dollar (NZD)
  • Swiss franc (CHF)
  • The Canadian dollar (CAD)
  • Australian dollar (AUD)
  • The British Pound (GBP)
  • Japanese Yen (JPY)

In the Forex market, the trades are usually expressed as a combination of two currencies being exchanged. Here are 7 popular currency pairs that are involved in the vast majority of trades.


How To Trade Forex

A vast majority of trades are not made for the sole purpose of exchanging the currencies, but largely to speculate about future price movements. In the same way as stock traders, the Forex traders try to buy the currencies whose value they think might increase relative to other currencies or sell currencies whose power they project will decrease.

Here are three ways to trade Forex. Check carefully to find one that can accommodate your trading goals.

  • The spot market: It’s the main Forex market where currency pairs are exchanged and the exchange rates determined, based on demand and supply.
  • The forward market: Rather than execute trades in a row, the Forex traders can enter into a private contract with another Forex trader and lock in the exchange rate for a specific amount of currency in the future.
  • The futures market: In the same way, traders can decide to get into a contract to sell or buy a predetermined amount of currency at a predetermined exchange rate. Unlike the forwards market, this is usually done in an exchange instead of privately.

The futures and forward markets are mainly used by the Forex traders looking to hedge against or speculate about the future price changes in the currency pairs.

Forex Terms

As you already know, every market has its own unique language. Here are some of the terms you should know before you dive into Forex trading.

  • Currency pair: Forex trades usually include a currency pair. Besides the majors, there are some unique trades such as exotics, a term used to refer to currencies of developing nations.
  • Pip (percentage in points): A pip is the smallest price change in a currency pair. Since Forex prices are quoted out to 4 decimal places, a pip is the equivalent of 0.0001.
  • Bid-ask spread: Like other assets such as stocks, the exchange rate is always determined by the maximum amount buyers can pay for the currency (the bid) as well as the minimum amount that the sellers can sell (the ask). The bid-ask spread is the difference between the two amounts and the value at which the trade will be executed.
  • Lot: The Forex is traded by a lot (a standardized currency unit). A common lot size is 100,000 currency units, although there are mini (10,000) and micro (1,000) lots available.
  • Leverage: This is another term for borrowing. It allows Forex traders to trade without the amount of cash required.
  • Margin: Participating in the Forex market with leverage is not free. Traders are required to put down some money as a deposit; this is what is known as a margin.


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