What is Forex Trading? - How Forex Trading Works

What is forex?

Forex (also known as FX) is simply shorthand for “foreign exchange”, which is the trading of one currency for another.

A forex trader speculates on the price movements of one currency against another with the aim of making a profit.

Key forex facts

The forex market's huge

Forex is the world’s most traded market with over $7.5 trillion* being traded every day. To put it in perspective, the monthly average volume for stock market trading is only $553 billion (7% of forex’s size)**

You’ve probably already traded FX

When you travel to another country, you usually exchange your money into the foreign currency to spend money there. Sometimes, whatever you don’t end up spending you’ll convert back. This is forex.

Currencies come in pairs

You’re always trading one currency against another, such as the US dollar against the Canadian dollar (USD/CAD). This is called a forex pair.

There are always trading opportunities

Forex is an exceptionally liquid and volatile market, and it’s reacting all the time. This makes it especially attractive to day traders looking for short-term wins.

There’s no centralized exchange

Unlike stocks which use exchanges such as the New York Stock Exchange, forex is traded by a decentralized global network of banks.

The FX market never sleeps

You can trade forex 24 hours a day, 5 days a week. This is because the time zones of the four trading centers (London, New York, Sydney, and Tokyo) overlap with each other. So, when one closes, another opens.

*April 2022 average daily volume from BIS 2022 Triennial FX Report
**August 2022 average notional value from Cboe Global Markets
The trading volumes provided above correspond to the global Interbank Market. FOREX.com clients do not have direct access to the Interbank Market, and the available liquidity is limited to the specific sources used by FOREX.com.

How forex trading works

Before we dig into the details, let’s take a look at a simplified forex trade.

Trading EUR/USD

You believe that the value of the euro will rise against the US dollar, because the EU reported strong economic growth.

So, you buy EUR/USD, meaning you’re buying euros while selling the US dollar.

Scenario 1: you are correct

Your analysis was spot on and the euro rises against the dollar.

Your position increases in value and you decide to close your trade and take your profit.

Scenario 2: you are incorrect

The markets don’t react the way you anticipated, and the euro falls against the dollar.

Understanding currency pairs

Forex is always traded in currency pairs, such as AUD/USD. This is because a currency cannot be speculated against itself; its value is always in relation to another currency.

But why does the AUD/USD pair look the way it does?

Every currency in forex trading is signified by three letters. These are known as the ISO 4217 Currency Codes.

The first two letters denote the country. The third represents the currency name.

AUD = Australia dollar
USD = United States dollar

Forex currency pair nicknames

As you become immersed in the world of forex, the currency pairs are often referred to by their nicknames. Here are just a few:

GBP/USD – Cable
EUR/CHF – Swissy
EUR/USD – Fiber
EUR/GBP – Chunnel 
NZD/USD – Kiwi

Types of currency pair

FX pairs are categorized into three types: majors, minors, and exotics.

Major currency pairs

As the name suggests, the ‘majors’ are the most popular traded currency pairs. They account for around 85% of the total FX trading volume and are represented by some of the world’s largest economies.

Over a quarter of all forex trades are in EUR/USD.

EUR/USD – the euro vs the US dollar 
USD/JPY – the US dollar versus the Japanese yen
GBP/USD – British pound sterling versus the US dollar
AUD/USD – the Australian dollar versus the US dollar 
USD/CHF – the US dollar versus the Swiss franc
USD/CAD – the US dollar versus the Canadian dollar

As they are so regularly traded, you’ll typically find the major pairs to have the tightest spreads (the difference between the sell and the buy prices). This makes them less costly to trade than other forex pairs.

What is the spread?

The spread is the difference between a market's buy and sell price. The tighter the spread, the more favorable the price is for the trader.

As we do not charge commissions on our spread-only account, the spread is how we as the forex provider make money from the trade.

In the same way a high-street retailer adds a little extra to the price when it buys stock from a wholesaler, the spread is how most forex providers compensate themselves for the service they provide.

Minor currency pairs

Minor pairs are currency pairs that don’t include the US dollar. They are also known as cross pairs.

Examples include:

EUR/GBP – the euro versus British pound sterling
EUR/CHF – the euro versus the Swiss franc
GBP/AUD – British pound sterling versus the Australian dollar
GBP/JPY – British pound sterling versus the Japanese yen
CAD/JPY – the Canadian dollar versus Japanese yen
CHF/JPY – the Swiss franc versus the Japanese yen
EUR/NZD – the euro versus the New Zealand dollar

As they are less traded than the major pairs (meaning the market is not as liquid), the spreads are usually wider than the major currency pairs.

Exotics

Exotic currency pairs consist of a major currency and a much less traded one, such as the US dollar versus the Chinese yuan (USD/CNH).

Many of the smaller currencies are from developing countries or small nations with strong economies. They often come with the largest spreads as they are the least traded type of pair.