What is Forex? • Forex Trading & How it Works • Benzinga

Currencies trade in pairs in the huge foreign exchange or forex market, which has become the world’s largest financial market in terms of its daily transaction volume. It was recently estimated at $6.6 billion per day.

The bulk of that massive forex transaction volume takes place in the unregulated over-the-counter forex market rather than on the sort of regulated exchanges where stocks trade. In recent years, the forex market has opened up to retail traders operating through online forex brokers.
If you are still curious about what is forex trading and whether it might be suitable for you, then you have come to the right place. Read on for more information about the forex market and how to get started as a forex trader.

How Does Forex Trading Work?

A forex trade refers to a type of financial transaction in which one currency is swapped for another currency at an agreed-upon rate of exchange or exchange rate. Exchange rates are set by market forces of supply and demand.

When it comes to notation, each national currency is traditionally represented by its unique three-letter currency code established under the ISO 4217 International Standard. Common examples of these codes include USD for the US dollar, EUR for the euro, GBP for the British pound, JPY for the Japanese yen, CHF for the Swiss franc, AUD for the Australian dollar, CAD for the Canadian dollar and NZD for the New Zealand dollars.

Since currencies trade in pairs in the forex market, the usual way to refer to a currency pair is to write the codes for the base currency and counter or quote currency separated by a slash (/). An example of this notation would be to use EUR/USD to refer to the exchange rate of the euro as the base currency quoted in terms of the US dollar as the counter currency.

The vast majority of forex transactions are done for value spot, which typically means for settlement in two business days, although forex traders usually avoid going to delivery altogether. Accordingly, when the FX market starts a new trading day at 5 pm NY time, a rollover is usually done on outstanding positions to keep them spot value so they can easily be traded in the spot market.

Forex trading is a speculative activity that has more in common with gambling than with investing, so only capital that you can afford to lose should be used as margin. Currency traders use technical and fundamental market analysis to forecast exchange rate movements. They then position themselves in the forex market according to their view on a particular currency pair.

For example, if a forex trader’s analysis suggests that the exchange rate for the EUR/USD currency pair should rise, then they would buy euros and sell US dollars. If that rise does materialize, then they can sell their position at a profit. If it does not, they might have to take a loss on the trade.

Understanding Forex Market Hours

The forex market trades 24 hours during the trading week that stretches from the Sydney open at 5 pm NY time on Sunday until the New York close at 5 pm NY time on Friday. The global forex market also has a series of trading sessions that overlap sequentially with each other.

Although some forex trading happens in Wellington, New Zealand, the forex trading day fully opens with the Sydney session. The Tokyo session then follows, after which the London and then the New York trading sessions take over market operations.

Why Trade Currencies?

In general, forex traders trade currencies speculatively with the goal of making a profit. The forex market also has a number of benefits over other financial markets that have sparked considerable interest among retail traders who can now easily participate in it.

Easy to Understand

Currency trading is easy to understand. Each currency in a pair has a set of fundamental factors that help determine its relative value that is usually based on economic and geopolitical conditions in its issuing nation. You can also use technical analysis on the exchange rate of a currency pair to help identify trends and time your trades.

Highly Liquid

Most of the forex market is very liquid. A trading position in a major currency pair can generally be traded out of readily and the gain or loss turned into cash without affecting its exchange rate. Although the forex market is one of the world’s most liquid markets, some currency pairs are more liquid during hours when they trade more actively. For example, the AUD/USD pair might be more liquid during the Sydney session’s hours, while the USD/JPY pair might be more liquid during the Tokyo trading session.

Cheaper to Trade

Most FX trades are done free of commissions or fees, which can make forex considerably cheaper to trade than stocks. Since the cost of a forex trade is generally fed into the dealing spread, a broker that offers tighter spreads will usually be cheaper to trade through.

Available 24 Hours a Day

The forex market trades around the clock. The currency market’s continual operation during those trading hours is facilitated by the opening and closing of the major global money centers.

Decentralized Market

The over-the-counter forex market is decentralized and largely unregulated. The market opens the typical trading day fully at the Sydney open (with some less active trading done in Wellington, New Zealand). That session is followed by full trading sessions in Tokyo, London and New York that sequentially overlap with each other. This decentralization means you can get a decent forex quote to open or close a position throughout each trading day.

Use of Leverage

In the retail forex market, leverage refers to the size of a trading position you can control with one unit of base currency placed on deposit with a broker as margin. Currency traders can use substantial leverage when trading currencies with leverage ratios ranging as high as 3000 to 1, although 500 to 1 is more common. To protect retail traders from losses, not all jurisdictions allow their residents to use such high leverage ratios when trading currencies, however. For example, the US has capped retail forex trading leverage at 50:1, while the UK and Australia have capped retail forex trading leverage ratios at 30:1.

Risks of Forex Trading

While forex trading has many benefits, it does have its associated risks that can result in losses. The most significant risks of FX trading are detailed below.

Volatile Market

Exchange rates can and do shift sharply to discount new information that can result in trading losses if you happen to be positioned on the wrong side of the market. While the forex market is not nearly as volatile as the stock market, the volatility that does occur can increase both profits and losses.

Too Much Leverage

Using more leverage than you can afford to can result in excessive losses than can wipe out your trading account.

Interest Rate Risks

Sudden shifts in benchmark interest rates set by central banks can cause the value of their national currencies to move sharply, which can cause substantial trading losses.

Transaction Risks

The risk of human error exists with just about any trading transaction you make personally. Some currency traders automate their trading plans or use automatic trading software to reduce this risk.

Country Risks

Each currency traded in the FX market has either one country or a regional group of countries associated with it. If something traumatic happens in that country or region, it will generally adversely affect the value of the currency and can result in unexpected trading losses.

How to Start Forex Trading

If you’re still interested in getting started as a forex trader, then the process is simple to initiate, although becoming successful can take years to achieve. Just follow the steps below to begin that journey.

Learn About Forex

You will first need to educate yourself about the forex market, what moves it and how to analyze it so that you can take more winning positions than losers. Many online resources of information and forex courses exist, and expertly written books and ebooks can also be helpful. In addition, you might want to enlist the services of a forex mentor to look over your trading strategy and how you are implementing it to help point you in the right direction.

Set Up a Brokerage Account

Your first step in being able to actually execute a forex transaction will involve setting up a margin trading account with a reputable online forex broker so that you can enter orders and hold positions.

Trading Strategy

Trading currencies without a plan and a well-thought-out forex trading strategy incorporated into it is like trying to find your way to a new location without a map. Before jumping into trading forex in a live account, be sure to take plenty of time to research a suitable trading strategy, learn how to implement it and then test it thoroughly in a demo account.

Stay on Top of Your Position

Once you start trading in a live account, you’ll want to stay aware of outstanding positions or orders waiting to be filled. Also, be sure to stay on top of your profit or loss numbers to make sure you can afford to keep a position and determine if you need to take prompt action to lock in profits or cut losses.

Benzinga’s Best Forex Trading Platforms

Benzinga has compiled the comparison table below to help you take some of the guesswork out of finding a reputable online forex broker to let you start trading currencies quickly.

Claim Exclusive Offers

Frequently Asked Questions

Related content: What Makes the Forex Market Move?