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What is Forex Trading and How Does it Work?

The foreign exchange (widely known as FX or forex) is a global marketplace where currencies are traded. National currencies are exchanged against one another worldwide, creating a daily average trading volume of around $5 trillion, making it the largest financial market in the world.

For this reason Forex trading is one of the most actively traded markets in the world since it relates to any conversion of one national currency into another.

The volume of currency forex brokers buy or sell everyday, affects the price movements, and can make some currencies extremely volatile. But this is also affected by several commercial activities, politics, changes in inflation/interest rates or recessions. Unlike stocks and commodities, there is no central exchange. Instead, currencies are converted via a global network of banks, dealers and financial brokers all over the world. The volatile nature of the market attracts many traders as there is an opportunity for high profits alongside the increasing risk.

$5.00 Trillion

$22.4 Billion

$18.9 Billion

$7.2 Billion
Forex Market
NY Stock Exchange
Tokio Stock Exchange
London Stock Exchange

How does Forex Trading work?

FX prices are quoted in pairs. All transactions made on the forex market depend on the buying and selling of two currencies at the same time. There is the Base currency on the left-hand side and the Quote currency beside it. There are many currencies traded in the market and these are split into three sections of pairs: Major, Minor and Exotic pairs.
Major forex pairs according to ESMA, refer to all currency pairs comprising any two of the following currencies: US Dollar, Euro, Japanese Yen, Pound Sterling, Canadian Dollar, or Swiss Franc. All other currencies are considered non-major. These are three of the most traded major forex pairs:
1. EUR/USD – Euro/U.S. Dollar
2. GBP/USD – British Pound/U.S. Dollar
3. USD/JPY – U.S. Dollar/Japanese Yen

Minor pairs

Minor pairs include 42 pairs in total. They have a smaller market share compared to major pairs, but still a very decent level of liquidity. These pairs are made up out of any combination of the following currencies:

  • Euro
  • British Pound
  • Canadian Dollar
  • Australian Dollar
  • Japanese Yen
  • Swiss Franc
  • New Zealand Dollar

Exotic pairs

Exotic pairs are currencies from emerging economies, which are then paired with major currencies or other exotic currencies and traded. These pairs have the least frequent trades when compared to major and minor pairs.

  • USD/HKD - U.S. Dollar/Hong Kong Dollar
  • USD/SGD - U.S. Dollar/Singapore Dollar
  • USD/ SEK - U.S. Dollar/Swedish Krona
  • EUR/TRY - Euro/Turkish Lira
  • NOK/SEK - Norwegian krone/Swedish Krone

Major currency pairs

EUR/USD   Euro/U.S. Dollar icon
EUR/USD Euro/U.S. Dollar
GBP/USD   British Pound/U.S. Dollar  icon
GBP/USD British Pound/U.S. Dollar
USD/JPY   U.S. Dollar/Japanese Yen icon
USD/JPY U.S. Dollar/Japanese Yen
USD/CHF   U.S. Dollar/Swiss Franc icon
USD/CHF U.S. Dollar/Swiss Franc
USD/CAD   U.S. Dollar/Canadian Dollar icon
USD/CAD U.S. Dollar/Canadian Dollar
AUD/USD    Australian Dollar/U.S. Dollar icon
AUD/USD Australian Dollar/U.S. Dollar
NZD/USD   New Zealand Dollar/U.S. Dollar icon
NZD/USD New Zealand Dollar/U.S. Dollar
When choosing a forex pair to trade, you may conduct fundamental and technical analysis of the two currencies. This essentially means assessing the entire market and evaluating how the Base and Quote currency you are observing are moving in relation to each other.

Benefits of Forex Trading

FX trading is one of the most popular financial markets. One reason is because, in particular, the major currency pairs are traded in extremely high volumes giving the market high liquidity. It is because of this size it is thought that forex trading is the most lucrative market out there.

A key advantage of FX trading is Leverage. This means you only need to put up an initial deposit, or margin, to enter a trade. Margins can vary depending on regulations, currency pair and the platform you choose to use. Margin trading can be a more efficient way of using your capital because you only need to present a percentage of the overall value, whilst remaining fully exposed to the fluctuations in the market. This essentially means you can increase your potential profit if the market trends in your favour.

The forex market is traded 24-hours a day. From Sunday night through to Friday night, trading takes place around the world. This means that investors can almost always be ready to respond to currency fluctuations. This is a key benefit as the markets are constantly moving, which places emphasis on monitoring your position and utilising appropriate risk management software.

All trades made on any serious forex platform are authorised and regulated by independent financial institutions, like CySEC or FCA. They enforce rules necessary to offer protection to stop retail investor accounts losing money, and help protect from fraud.

Given the high volatility of the forex trading market, it’s recommended to practice with a demo account as it helps beginners learn and practise trading, before diving into the world of forex.

How does the Forex Market work?

As businesses continue to expand into markets all over the globe, the need to complete transactions in other countries’ currencies is only going to grow. There are constant fluctuations in currency values, and this places businesses at risk when buying goods or services outside of their borders.

The FX market provides a means of hedging that risk by fixing a rate at which the transactions can be completed at a later date. Investors speculate the market when trading forex, in the hopes that the currencies traded will gain or drop in value resulting in a profit.

There are different products available to trade and it is essential to research as much as possible before you start, for example, CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage.

Doing your due diligence on key terms, types of products to do forex trading and the differences in currency pairs, will go a long way to helping you make sense of the market, and effectively participating.

Factors which affect the
Forex Market

Current Account Deficit
Interest Rate

Factors which affect the
Forex Market

Public Debts
Terms of Trade
Political Stability