What is forex trading? A complete guide

Forex trading is a common way to gain access to the foreign exchange market, the most-liquid market in the world.

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What is forex trading?

Foreign exchange trading – also known as forex trading or FX trading – is the process of buying and selling currencies with the goal of making a profit from fluctuations in their exchange rates.

Currency pairs are the cornerstone of every transaction in forex trading. A currency pair consists of two different currencies traded in relation to one another. These pairs determine the exchange rate between the two currencies.

The first currency in the pair is called the base currency, and the second is the quote currency. The value of the pair shows how many units of the quote currency are equal to one unit of the base currency.

For example, in the popular EUR/USD pair, the euro (EUR) is the base currency, and the US dollar (USD) is the quote currency. If the EUR/USD rate is 1.1000, it means that 1.1 US dollars equals 1 euro. If it rises to 1.1200, it means that 1.12 US dollars equals 1 euro.

What are the types of currency pairs in forex trading?

Currency pairs are categorised into three main groups: major, minor, and exotic pairs.

• Major currency pairs consist of the most liquid and widely traded currencies globally, such as EUR/USD (euro/US dollar), USD/JPY (US dollar/Japanese yen), and GBP/USD (British pound/US dollar, also known as cable). These pairs typically offer high liquidity and are usually associated with lower spreads.
• Minor currency pairs, also known as ‘cross-currency’ pairs – do not include the US dollar in their pairing. Examples include EUR/GBP (euro/British pound) and AUD/JPY (Australian dollar/Japanese yen). Although these pairs may have slightly wider spreads and lower liquidity than the major pairs, they are still widely traded.
• Exotic currency pairs involve one major currency and one currency from a smaller or emerging economy, for example, USD/TRY (US dollar/Turkish lira) or EUR/TRY (Euro/Turkish lira). These pairs can be more volatile and less liquid compared to majors and minors, meaning their price fluctuations may be more severe, making it additionally important to trade with caution.

What are the most popular forex pairs to trade

You may choose certain currency pairs over others due to their high liquidity and market activity. The major currency pairs are known for their substantial trading volumes and often relatively tight spreads. So it’s no surprise that the majors are the most traded currency pairs in the world by volume. They include:

• EUR/USD (euro/US dollar)

• USD/JPY (US dollar/Japanese yen)

• GBP/USD (British pound/US dollar)

• AUD/USD (Australian dollar/US dollar)

• USD/CHF (US dollar/Swiss franc)

• USD/CAD (US dollar/Canadian dollar)

• NZD/USD (New Zealand dollar/US dollar)

Some forex traders also choose to trade minor pairs, such as EUR/GBP (Euro/British pound), or exotic pairs, like the USD/TRY (US Dollar/Turkish lira) to diversify their portfolio and spread risk.

Discover the most traded currencies in the world on our most traded currencies page.

How does forex trading work?

Forex trading is highly liquid, with over $7.5 trillion traded daily. Traders enter the market for various reasons – seeking profits, hedging against currency risks, or simply diversifying their portfolios. Here, we’ll explore key elements that define how forex trading works, from understanding bid and ask prices to the role of speculation, liquidity, accessibility, and risk management.

Bid and ask prices

Forex trades involve two prices: the bid price (the price at which the broker is willing to buy the base currency) and the ask price (the price at which the broker is willing to sell the base currency). The difference between these two prices is known as the spread.

Speculation

Forex traders aim to profit from price fluctuations in the exchange rate of currencies by either going long or short on selected pairs. For example, if you are trading EUR/USD and you go long, it’s because you believe EUR will rise, USD will fall, or a combination of both. As with any type of trading, there’s also a high risk of losing money too.

Liquidity

The forex market is often highly liquid, meaning there’s a constant flow of buyers and sellers. It’s thanks to this liquidity that forex traders can enter and exit positions in most major pairs with relative ease and at the price they intended. However, some markets, such as exotic pairs, are traded in much lower volume and can therefore mean a higher risk of slippage.

Accessibility

Due to low entry barriers, forex trading is accessible to a wide range of traders – including retail traders. Many brokers, like us, offer leverage, allowing forex traders to control larger positions with a relatively small amount of money, providing the possibility for larger profits, but also larger losses.

Diversification

Some traders choose to trade forex to diversify their investment portfolio, and some choose to trade various currency pairs at once – including major, minor, and exotic pairs – to spread risk.

Flexibility

Due to its decentralised nature, the forex market operates 24 hours a day, five days a week, across the world. This flexible nature allows traders to buy and sell forex whenever it suits them.

Risk management

Some traders use forex to hedge against currency risk. As for businesses involved in international trade, they can use forex markets to protect against adverse currency movements that could impact their profits.

Forex trading example

What influences the prices of forex currency pairs?

Forex rates fluctuate constantly, based on patterns of demand between the two currencies in a pair. Here are some of the main ways currencies shift in price.

Economic releases

The value of a nation’s currency is determined significantly by the health of its economy. Forex markets react to releases of key economic data, as they give a picture of how the country’s economy is performing and how it compares with other countries. For example, if a country’s GDP announcement reveals a better-than-expected economic performance, its currency may strengthen against others.

Political news and events

Currency prices also react to domestic and international political news and events. As the global reserve currency, the US dollar is considered a safe haven, which increases its value during times of macroeconomic uncertainty and political instability. For example, a political crisis in the UK may lead to a sell-off in the British pound, which may in turn make the US dollar more attractive.

Interest rates

A country’s monetary policy stance, for example in response to persistent inflation or poor economic performance, is an important driver of forex prices. Higher interest rates often cause a currency to appreciate as investors seek a bigger return by acquiring that currency. Meanwhile, lower interest rates may lead market participants to choose other currencies instead.

In forex trading, exchange rates fluctuate due to various factors, including interest rates, inflation, and economic indicators such as purchasing power parity (PPP), which compares the relative value of currencies based on price levels.

Commodity prices

The cost of commodities can impact currencies depending on whether the countries involved are net importers or net exporters. For example, a significant increase in the oil price can benefit oil-exporting countries like Canada, leading to greater demand for Canadian dollars and an appreciation of its currency against others. Currencies of countries that export large volumes of commodities, such as the Australian dollar, New Zealand dollar and Canadian dollar, are often referred to as commodity currencies.

What are the forex trading hours?

The forex market operates 24 hours a day, five days a week, across major financial centres worldwide, divided into four major trading sessions – London, New York, Sydney, and Tokyo.

Major forex market sessions

Unlike stock markets, which operate on a set schedule — forex trading hours follow the global financial hubs, allowing traders to buy and sell currencies at any time within the trading week.

Get the latest forex market trading hours on our forex trading hours page.

What are lots in forex trading?

In forex trading, a lot is the standard unit size used to measure a trade. As a standardised metric for trade sizes, lots can help forex traders manage their positions. 

Lot size affects the value of a pip movement. In forex, a pip is typically the smallest price movement in a currency pair, usually the fourth decimal place – except for JPY pairs, where it is the second decimal place – (for example, in EUR/USD, a move from 1.1000 to 1.1001 is one pip, whereas in USD/JPY, a move from 110.00 to 110.01 is one pip).

There are four main lot sizes: standard, mini, micro, and nano.

For example, if you are trading a standard lot (100,000 units) of EUR/USD, and the price moves one pip in your favour, your profit would be $10 per pip. If it moves against you, your loss would also be $10 per pip.

At Capital.com, we make forex trading even more straightforward by offering it in increments of 100 units. That means you don’t need to deal with traditional lot sizes, making your trading experience simpler and more practical.

Find out more about lots in forex trading in our trader’s guide to forex lots.

What are forex swaps?

Forex swaps – also called ‘FX swaps’ – are agreements between two parties to exchange currencies at two different dates. Initially, one currency is bought while the other is sold at an agreed rate (the near leg). The second exchange occurs at a future date, with the rate determined by the interest rate differential between the two currencies (the far leg).

Traders could use forex swaps for different purposes:

• Short-term swaps last a few days to weeks and are used to manage liquidity, hedge short-term currency risk, or optimise carry interest costs based on interest rate differentials.

• Long-term swaps can extend for months or even years and are often used by businesses or investors to manage ongoing currency exposures in cross-border investments or debt repayments.

Check out our trader’s guide to forex swaps to learn more.

Trading forex vs stocks: What are the differences?

Forex and stock trading are two of the most popular financial markets, but they are distinct. Below, we compare key differences between forex and stocks.

Learn more about forex & stock markets on our forex vs stocks guide.

Forex trading strategies to consider

Forex traders use various strategies to structure their approach to the market. These strategies incorporate elements of technical and fundamental analysis, so it’s important to be familiar with both before deciding which to use.

Trend trading strategy

Trend trading strategies aim to capitalise on sustained price movements by identifying trends in the forex market. A trend occurs when a currency pair moves consistently in one direction—either upwards (bullish) or downwards (bearish).

Scalp trading strategy

Scalping is a short-term trading strategy that involves making multiple trades throughout the day to capture small price movements. Scalpers aim to profit from minor fluctuations in forex prices, often holding trades for just a few minutes.

Swing trading strategy

Swing traders aim to capture price swings within a broader trend, holding positions for several days or weeks. This strategy blends technical and fundamental analysis to identify potential entry and exit points.

Discover more forex trading strategies on our forex trading strategies page.

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