What is forex trading and how does it work?

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

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 objective of making a profit from fluctuations in their exchange rates.

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

The first currency in the pair is the base currency, and the second is the quote currency. The value of the pair is determined by how many units of the quote currency is 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, that means that 1.1 US dollars equates to 1 euro. If it rises to 1.1200, that means that 1.12 US dollars equates to 1 euro. 

Classifying currency pairs

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.

Popular forex currency 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.

What moves forex prices?

FX 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.

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.

Why trade forex

Traders choose forex trading for various reasons, ranging from profit-seeking to hedging against currency risks. Here are some of the most common reasons.

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 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.

How to trade forex with leverage

You can trade forex currency pairs through financial derivatives such as CFDs and spread bets, which give you leveraged exposure to the fluctuating exchange-rate price. It’s the underlying price fluctuations that traders attempt to profit on when taking a position. By trading forex with leverage, you can control large positions with a relatively small amount of capital, or ‘margin’. However, it’s important to remember that forex trading with leverage can also amplify losses, so traders must use it with caution and have a solid risk-management plan in place.

Costs involved in forex trading

As with all of our markets, when you trade forex with us you’ll pay a spread, which is based on the difference between the market price at which you can buy, (also called the offer/ask) and the price at which you can sell (or the bid price). For example, if you’re trading EUR/USD, our spread is 0.00006, which you will pay on the opening and closing of the trade. The correlation between the bid, the ask, and the spread looks something like this:

You may also pay additional fees, for example if you use a guaranteed stop-loss* or if you hold a trade overnight, as well as forex conversion fees where applicable. As with all Capital.com instruments, you won’t pay any commission when forex trading on our platform.

It’s advisable always to make sure you’re aware of the cost of trading before you open a position. You can do this via our charges and fees page.

*Stop-losses are not guaranteed, but we offer guaranteed stop-losses (GSLs) for a fee. You can check the GSL fee value in a deal ticket when opening a position and adding a GSL.

How to trade forex with Capital.com

You can trade forex with us by following these steps:

• 1. Choose a currency pair to trade, based on your trading goals
• 2.  Choose whether to trade with a CFD or spread bet
• 3. Decide on your trade size
• 4. Consider applying a stop-loss to manage risk
• 5. Open your position long or short
• 6. Manage your position, monitoring fundamental and/or technical drivers
• 7. Close your position

Forex trading examples

Why trade forex with Capital.com

We’re proud to have won a range of awards from some of the leading authorities in the trading world, including Best CFD Provider 2023 at the Online Money Awards. We’re rated Excellent on Trustpilot, and we’re always working to improve the experience of our 500,000+ clients.

Here are just a few reasons to choose us for forex trading:

• Clear, easily-navigable interface across desktop, app and tablet
• Rapid withdrawals*
• Multiple chart types and 75+ technical analysis tools
• Insightful education via courses, videos and webinars, as well as an in-platform, asset-specific Reuters feed
• Round-the-clock support

Stay up to date with the latest forex news and analysis.

*98% of withdrawals are processed within 24 hours, according to our internal server data from 2022.

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