Forex trading explained: How to trade forex

Forex trading is the process of buying and selling international currencies with the objective of making a profit from fluctuations in the exchange rates between different currencies.

The term ‘forex’ stands for foreign exchange. Forex market allows trading fiat currencies of different countries against each other. For example, trading British pound against the US dollar (GBP/USD).

GBP/USD exchange rate

What is forex trading?

What is forex trading and how does it work? Currency or foreign exchange trading – often known as FX – is trading pairs of currencies to try to potentially benefit from fluctuations in the exchange rates.

While assets such as stocks and commodities are traded on regulated central exchanges, currencies are bought and sold over the counter (OTC) – meaning that trades are conducted largely between institutional counterparties in major forex trading centres around the world. This is called the interbank market.

The biggest and the most liquid of these FX trading centres are London and New York. Tokyo, Hong Kong, Frankfurt and Singapore are also important currency trading centres. 

Read on to find out how to trade forex for beginners.

Past Performance is not a reliable indicator of future results.

What is the forex market?

Forex is the world's most active market by the volume of trading and, with close to $7trn worth of transactions every day, the biggest market in terms of value.

Given the market’s international reach, forex trading is conducted 24 hours a day, except weekends, and determines the foreign exchange rates for all of the world's currencies.

About currency pairs

How does forex trading work? Forex investors trade currency pairs – sometimes called crosses for pairs that don’t include the US dollar – assessing when one currency is likely to rise against another. 

Forex trading meaning presupposes buying one currency while selling another. Traders try to potentially profit by selling a currency at a higher value than when they had purchased it. A currency pair features a base currency and a quote currency. The exchange rate represents how much of the quote currency is needed to buy one unit of the base currency. 

Each currency is represented by a three-letter code, with the first two often referring to the country and the third referring to the currency – for example USD for the US dollar, CAD for Canadian dollar and NOK for Norwegian krone. There are exceptions, such as EUR for the euro and MXN for the Mexican peso.

The most frequently traded forex pairs include the euro against the US dollar (EUR/USD), the US dollar against the Japanese yen (USD/JPY) and the British pound against the US dollar (GBP/USD).

A forex trader buys and sells the pairs when they expect the value to fluctuate. For example, if a trader believes the euro will rise against the dollar – maybe because of strong economic data in the eurozone – they could take a long position on the EUR/USD currency pair. If they expect the value of the euro to fall, they could short the pair.

There are four main types of forex pairs that traders deal in, depending on their strategies:

• Major pairs: These are the most actively-traded pairs and offer greater liquidity and lower volatility. There are seven major currency pairs, all of which are US dollar crosses – GBP/USD, EUR/USD, USD/JPY, USD/CHF, USD/CAD, NZD/USD and AUD/USD. These account for 88% of all forex trading.

• Minor pairs: These are currency pairs that do not include the dollar as one of the crosses. They are generally less liquid so can see greater price volatility. This means – for the purpose of CFD trading – they can offer greater opportunities for profit and loss. EUR/GBP, EUR/AUD, GBP/JPY, NZD/JPY and GBP/CAD are examples of minor currency pairs.

• Exotic pairs: These usually include a cross from an emerging market country. Low liquidity and high volatility can make for some rapid and unpredictable price swings. Examples include EUR/TRY, USD/HKD, NZD/SGD, GBP/ZAR, NOK/RUB and AUD/MXN.

• Regional pairs – These are currency pairs based on region, such as Scandinavia or Australasia, and include NOK/SEK, AUD/NZD, AUD/SGD and CNH/HKD.

Common forex market terms

Before you learn how to start forex trading, it's useful to know some of the common language used by traders. Here's a simple glossary of some of the terms you'll come across:

Aussie – slang term for the Australian dollar

Ask price – the price at which a trader can buy

Base currency – the first currency shown in a currency pair - in USD/EUR the US dollar is the base currency

Base rate – the lending rate set by a country's central bank

Basis point – equal to 1/100th of 1%, or 0.01% - or 0.0001 in the price of a currency pair. Often called a "pip"

Bear market/bearish – indicating a market or asset price in decline

Bear – traders who expect prices to fall and may be holding short positions

Bid-ask spread – the difference between the buy price and the sell price

Bid price – the price at which a trader can sell

Bull market/bullish – indicated a market or asset price that is rising

Bull – a trader who expects prices to rise and may be holding long positions

Cable – slang term for the GBP/USD currency pair

Counter currency – the second currency in a currency pair - in USD/EUR the euro is the counter currency

Counterparty – a participant in a transaction

Day trading – entering and exiting a forex trade on the same day. This is the typical strategy employed on CFD trading platforms

Derivative – a financial product whose value is based on an underlying asset

Dollar index – a measure of the US currency's strength relative to a basket of other currencies that include the euro, the pound and the yen. Its symbol is DXY

Dove/dovish – relating to monetary policy that supports lower interest rates. Opposite of hawkish

Greenback – slang term for the US dollar, also buck

Hawk/hawkish – relating to monetary policy that supports higher interest rates. Opposite of dovish

Hedge – a trading position or positions that helps reduce risk on your primary trading positions

Kiwi – slang term for the New Zealand dollar

Leverage – this allows a trader to open positions much larger than his up-front capital can cover. It means that you can maximise your profits significantly on winning trades, but risks you losing much more than your initial deposit. Take note of the risk warnings on trading platforms and trading apps that offer leveraged trading

Liquidity – a highly liquid market has enough volume of trade to ensure smooth price movements. Illiquid markets have low levels of trading activity and can result in price volatility

Loonie – slang term for Canadian dollar

Lot – forex is traded in units of currency known as lots. The typical lot size is 100,000 units, although you can also deal in mini lots of 10,000 units and micro lots of 1,000 units.

Margin – margin is related to leverage, and represents the minimum amount of cash you need to deposit to trade at your specified leverage

Margin call – when your open position moves against you, your broker will make a margin call for you to supply additional funds to cover your margin

Open position – an active trade

Pip – stands for "price interest point" and is the smallest amount by which a currency pair's price can change. On quoted currency pairs, a single pip will be 0.0001.

Spread – this is the difference between the bid - or sell - price, and the ask - or buy - price on a currency pair.

Sterling – alternative name for the UK pound

Tick – a minimum change in price, or a pip

What moves forex prices?

FX rates fluctuate constantly throughout the day, based on whether one currency is in higher demand than the other. As the forex market covers currencies from around the world, there are many factors that can drive the direction of different pairs, based on their perceived value to pay for goods and services or to invest in. 

If you want to learn forex trading, here are some of the factors that can affect currency values you need to know about.

Economic releases

The value of a nation’s currency is in large part determined 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.

Gross Domestic Product (GDP), which measures the value of all the finished goods and services a country produces in a certain period, is one of the most important metrics to gauge a country’s economic performance.

Political news and events

Currency prices also react to political news and events domestically and internationally. 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. 

An example of the impact a political event can have on the currency would be the Russian ruble, which lost a third of its value in the two weeks after Russia invaded Ukraine and Western countries imposed sanctions. The rouble reversed the price action later, quickly recovering to the pre-invasion levels and above amid higher oil and gas prices. 

Interest rates

A country’s monetary policy stance in response to inflation is an important driver as higher interest rates attract investors to earn higher returns on their money. For this reason, forex rates tend to move in favour of the currency that has the highest interest rates. 

Commodity prices

The cost of commodities can drive currencies in different directions depending on whether their countries are net importers or net exporters. Currencies from countries that export large volumes of commodities, such as the Australian dollar, New Zealand dollar and Canadian dollar, are called commodity currencies.

How to trade forex

If you are interested in how to trade forex, there are several instruments you can use depending on your trading strategy and market predictions.

The vast majority of FX transactions are executed by large institutions through the interbank market, often running into hundreds of millions of dollars at a time. But with the advent of online forex trading platforms – as opposed to physical exchanges – retail traders can now get involved in the currency markets too.

Spot FX

Accounting for $2trn of the total FX market, spot trading is a direct agreement between two counterparties to buy one currency against selling another and take delivery at an agreed price on settlement date. 

Individual investors are not involved in the spot market. Unlike other instruments like futures, options and exchange-traded funds (ETFs), which are traded through centralised exchanges, spot forex contracts are traded on over-the-counter (OTC) contracts between the counterparties.

The primary spot forex market is the “interdealer” market, where dealers trade with each other. It is also known as the “interbank” market, as banks are the main dealers. The interdealer market is only accessible to institutions such as banks, insurance companies, pension funds and big corporations that trade in large volumes.

Currency options

Options are financial instruments that give the buyer the option to buy/sell an asset at a set price on a specified expiry date. If a forex trader buys an option, they are able to buy a currency at a specified exchange rate on the expiration date.

Unlike spot forex contracts, options and futures are traded on exchanges. However, while forex markets trade around the clock, trading options is limited to exchange operation hours and liquidity is lower than on the spot and futures markets.

Currency futures

Forex futures were created by the Chicago Mercantile Exchange (CME) in 1972 and continue to trade on exchanges.

Futures are contracts that obligate the trader to buy or sell an asset at a set price on a specified date in the future. That is the main difference between an option and a futures contract – options give traders the option to buy or sell, while futures obligate them to execute the trade. Forex traders use futures to speculate on the value of a currency on the expiry date. 

Currency ETFs

Exchange-traded funds (ETFs) are a type of investment fund that trade on stock exchanges through the trading session, unlike mutual funds that settle the price once a day. Currency ETFs offer investors exposure to a single currency pair or a basket of currencies without having to manage individual trades on the forex market.

Financial institutions manage currency ETFs by buying, selling and holding currencies in the fund. They offer investors shares of the fund, allowing them to trade the funds like stocks. Similarly to options and futures, ETFs are only available for trading during an exchange’s working hours. They also charge investors commission and transaction fees.

Retail platforms

While individual investors are not able to participate in spot FX trading, there are forex trading platforms that give retail traders access to the secondary OTC market. 

Forex trading providers are financial institutions that trade on the primary market on behalf of individual traders. They add a markup to the primary OTC prices to cover the cost of the service. Rather than trading the currency, the retail trader buys or sells a leveraged contract on the currency and cannot take delivery, so on expiry the contract is rolled over rather than cash settled. Bear in mind that leverage means that both profits and losses can be magnified.

Contracts for difference (CFDs)

Due to the large volumes involved most brokers won't indulge currency traders unless they can put up large amounts of cash for spot or derivatives trade. However, individuals can trade FX contracts for difference (CFDs) on online trading platforms. 

What are forex CFDs?

A CFD is a financial contract between an investor and broker, where one party agrees to pay the other the difference in the value of an asset or security. 

This gives a trader the choice between speculating on the currency pair in both directions.

Long: for example, if you think the euro will rise against the dollar you can take a long position on the EUR/USD

Short: if you believe the euro will depreciate against the dollar you can take a short position on the currency pair

What is the difference between a futures contract and a CFD?

While futures contracts and CFDs both allow traders to speculate on the direction of an asset price, there are differences in how they work in practice. 

While futures are traded on public exchanges and are therefore highly transparent, CFDs are traded directly with the broker. This can make CFDs more liquid, as the broker can act as a market maker and ensure the position is filled as soon as the order is placed. 

Futures have a set expiration date and their value tends to fall as it approaches, but CFDs do not have a set end date. CFDs are more accessible for traders with smaller portfolios, as futures tend to have large contract sizes.

What is a forex trading strategy?

Before you open your first position, it’s important to have a forex trading strategy to direct your approach. There is a wide range of forex trading strategies you could use to help you remain consistent and minimise emotional biases affecting your decision-making. 

An effective approach to forex trading uses a combination of technical and fundamental analysis to inform every trading decision.

Day trading

Day traders use technical analysis tools to identify price trends so they can enter and exit a trade in the same day. Day trades can be held open for hours. 

By closing their positions before the end of the day, day traders avoid exposure to overnight financing charges and fundamental developments that could affect the price the next day.

Swing trading

Swing traders hold their trades open for several days or weeks to capture price swings. Traders use technical analysis to identify likely turning points – tops or bottoms – in the price of a currency pair and enter long or short positions accordingly.

Position trading

This is a long-term strategy focused on fundamental analysis to determine when to buy or sell. Position trading is another approach to trading forex that involves a long-term buy and hold strategy that speculates on the direction of an asset price over a period of time, which can last months or even years.

Trend trading

Trend trading can be employed over long, medium and short-term periods and involves the technical analysis of historical price movement to identify future trends. Traders use various oscillator tools on technical analysis charts to identify entry and exit points for a trade.

How to trade forex CFDs

Do you want to know more about how to trade forex CFDs? Sign up for an account with a CFD provider like Capital.com. You can trade CFDs on forex along with stocks and commodities in the same trading account.

Follow these simple steps to get started:

1. Create and login to your trading account.
2. Choose which currency pair you want to trade.
3. Use your preferred trading strategy to identify potential buy and sell opportunities.
4. Open your first trade and consider using risk management tools such as a stop loss. 
5. Monitor your trade using technical indicators and fundamental analysis based on your strategy.
6. Close your position when your trading strategy indicates.

Pros and cons of trading forex CFDs

There are several advantages and risks of using CFDs to trade forex.

Leverage. Leverage can amplify gains and magnify losses. You can trade CFDs on margin, meaning you can open bigger positions using smaller amounts of capital. This is done by putting up only a fraction of the value of a trade and essentially borrowing the rest from your broker. This is known as leveraged trading. It can amplify your profits. However, leveraged products can multiply the size of losses if the price moves against your position. It is important to do your own research and understand how leverage works before you start trading.

Hedging. Hedging is the strategy where a trader opens a position to offset any potential loss that their current holdings may incur. The forex market is particularly volatile, which is what attracts a lot of traders. However, some may still want to employ hedging techniques to mitigate a loss. Traders can take positions in markets that are negatively correlated, such as holding a long position on USD/CAD to hedge against falling oil prices.

Why trade forex CFDs with Capital.com

Advanced AI technology at its core: A personalised news feed provides users with unique content depending on their preferences. The neural network analyses in-app behaviour and suggests videos and articles that fit your investment strategy. This will help you to refine your approach when you trade forex CFDs.

Trading on margin: Providing CFD trading on margin (up to 200:1 for major currency pairs), Capital.com gives you access to the wide range of popular forex markets without the need to have a large amount of funds in your account. Keep in mind that CFDs are leveraged products, which means both profits and losses can be magnified. 

Trading the difference: When trading CFDs on currency pairs you don’t buy the underlying base currency itself. You instead speculate on the rise or fall of its value. A CFD trader can go short or long, set stop and limit orders and apply trading scenarios that align with their objectives. CFD trading is similar to traditional trading in terms of its associated strategies. However, CFD trading is usually short term in nature, due to overnight charges and risks associated with leverage if compared to traditional trading.

All-round trading analysis: The browser-based platform allows traders to shape their own market analysis and forecasts with sleek technical indicators. Capital.com provides live market updates and various chart formats, available on desktop, iOS, and Android. Study live currency pairs within the platform while simultaneously browsing tailored news based on your trading behaviour.

Sign up at Capital.com and use our web platform or download the trading app to trade CFDs on the go. It will take you just three minutes to get started and view the world’s most traded forex pairs.

Forex market trading hours 

As the foreign exchange markets include currencies around the world in all time zones, forex trading hours are around the clock on weekdays. 

The markets are open 24 hours a day from 17:00 EST on Sundays until 16:00 EST on Fridays. The best time to trade forex could be when major market drivers, like economic data releases and political events, drive fluctuations in currency exchange rates and you can speculate one the movement. 

FAQs