How Does Foreign Exchange Trading Work?

How Forex Works

Since you’re reading this guide on how Forex works, let’s assume that you have a computer with internet. This leads us to the remaining two prerequisites for trading – a brokerage account and a trading platform. All currencies have their characteristics and behave differently during certain market conditions. Safe-havens such as the Japanese yen, US dollar, and Swiss franc usually appreciate when investors are risk-averse, while risk currencies such as the Australian and New Zealand dollar tend to fall in value during those times.

How does Forex trading work?

Forex is the largest financial marketplace in the world. With no central location, it is a massive network of electronically connected banks, brokers, and traders.

A stop-loss order automatically closes your position when the price reaches the pre-specified stop-loss level. If you place a 100-pip stop-loss, your broker will automatically close your trade when the price goes against your position for 100 pips. Stop-losses are important for risk management, so make sure that the total potential loss of your trade represents only a small percentage of your trading account size.

The platform will automatically convert the position margin amount into your account currency at the prevailing CMC Markets conversion rate. In FX trading, the asset is always a set of two currencies called a currency pair. Currencies are quoted in pairs, as two currencies are bought and sold simultaneously.

All currency trading is done in pairs. Unlike the stock market, where you can buy or sell a How to choose forex broker single stock, you have to buy one currency and sell another currency in the forex market.

Assuming there is no slippage when you open a buy (long) trade, your order gets executed at the ask price. This is the lowest price at which your broker is willing to sell the pair to you at that specific moment. When you close that same trade (by selling the position to the broker), you will receive the bid price, which is usually lower than the ask price. The bid price is the highest price your broker is willing to pay for the pair at any specific moment in time.

Now, you’ll notice that many forex transactions are only done for practical and convenience purposes, where you have to convert your money from one currency to another so you can use it to make certain purchases or payments. National central banks play an important role in the foreign exchange markets. They try to control the money supply, inflation, and/or interest rates and often have official or unofficial target rates for their currencies.

In forex trading terms this value for the British pound would be represented as a price of 2.0000 for the forex pair GBP/USD. Currencies are grouped into pairs to show the exchange rate between the two currencies; in other words, the price of the first currency in the second currency. One unique aspect of this international market is that there is no central marketplace for foreign exchange. Rather, currency trading is conducted electronically over-the-counter (OTC), which means that all transactions occur via computer networks between traders around the world, rather than on one centralized exchange. The market is open 24 hours a day, five and a half days a week, and currencies are traded worldwide in the major financial centers of London, New York, Tokyo, Zurich, Frankfurt, Hong Kong, Singapore, Paris and Sydney—across almost every time zone.

  • Investors or speculators who exchange currencies, which either require a foreign currency, to perform trading in equities or other asset classes from overseas or either are trading currencies with the aim of making a profit from market changes.
  • Here is an example of a FOREX trade.
  • A forecast that one currency will weaken is essentially the same as assuming that the other currency in the pair will strengthen because currencies are traded as pairs.
  • Each currency in the pair is listed as a three-letter code, which tends to be formed of two letters that stand for the region, and one standing for the currency itself.

Currencies are important to most people around the world, whether they realize it or not, because currencies need to be exchanged in order to conduct foreign trade and business. If you are living in the U.S. and want to buy cheese from France, either you or the company that you buy the cheese from has to pay the French for the cheese in euros (EUR). This means that the U.S. importer would have to exchange the equivalent value of U.S. dollars (USD) into euros. The same goes for traveling. A French tourist in Egypt can’t pay in euros to see the pyramids because it’s not the locally accepted currency.

A Bloomberg article in November 2014 noted that based on reports to their clients by two of the biggest publicly traded forex companies – Gain Capital Holdings Inc. (GCAP) and FXCM Inc. (FXCM) – 68% of investors had a net loss from trading currencies in each of the past four quarters. While this could be interpreted to mean that about one in three traders does not lose money trading currencies, that’s not the same as getting rich trading forex.

Exotic Pairs

Smart trading involves choosing your forex broker wisely, utilizing a reliable trading platform and picking your trading tools smartly. Hopefully, the above pointers will provide you with information that will go a long way in increasing your forex trading knowledge, which is key if at all you are to be successful in the forex trading world. Currencies are always quoted in pairs, such as GBP/USD or USD/JPY. The reason they are quoted in pairs is that, in every foreign exchange transaction, you are simultaneously buying one currency and selling another.

Trading currencies can be risky and complex. The interbank market has varying degrees of regulation, and forex instruments are not standardized.

With over 65 currency pairs to choose from, picking a trading opportunity that’s right for you is important. CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. 76% of retail investor accounts lose money when trading CFDs with this provider. You should consider whether you understand how CFDs work and whether you can afford to take the high risk of losing your money.

Forex trading should be a formula and a method that is enacted consistently and without emotion. Just like with trading stocks, forex traders can speculate on the fluctuating values of currencies between two countries, and it’s done for entertainment and profit.

When you close that same trade (by buying it back from the broker), you will pay the ask price, which is usually higher than the bid price. The ask price is the lowest price your broker is willing to receive for selling the pair at any specific moment in time. With a short trade, your trade will be at break-even when the ask price declines to the level at which your trade was executed.

How Forex Works