| Updated: November 20, 2024Foreign exchange (also known as forex, or FX) is an enormously important aspect of the global financial system. Its daily trading volume was estimated at US$7.5 trillion as of April 2022 and it has implications for millions of traders worldwide.
In this Guide to Forex Trading, we will cover everything about forex, the way the financial market works, and various aspects of forex trading. We will guide you through all the terms you need to know in your preparation for your journey into forex trading.
What is forex?
Let’s start with the basics. Forex, or foreign exchange, is a financial market where one currency is exchanged for another at a certain price. Forex prices are quoted for currency pairs and reflect the value of one currency in relation to the value of another currency.
What is a forex pair?
There are always two sides to forex prices. As such, forex prices are always quoted in pairs. When you buy one currency, you must always sell another that acts as its counterpart in the forex pair.
EUR/USD is the most traded forex pair in the world. The pair reflects the value of the euro compared to that of the US dollar. The euro (EUR) is the “base currency” (which is first) and the US dollar (USD) is the “quote currency” or “counter currency” (which is second).
A forex price quote shows how many units of the quoted currency you will need to exchange a single unit of the base currency. In the case of EUR/USD, it shows how many US dollars it would take to buy 1 EUR or to sell 1 EUR.
Majors, Crosses and Exotics
Currency pairs traded on the global forex market are commonly divided into three main categories. In this guide, we will take a look at the currency pairs that are most commonly traded on the forex market. According to the United Nations, there are 180 currencies and these are used in 195 countries. As many as 37 currencies contain the word “dollar” in their name, with some of the most popular examples being the Australian dollar (AUD), the Hong Kong dollar (HKD), the Singapore dollar (SGD), and of course, the US dollar (USD).
Forex pairs are formed by coupling different fiat currencies. Based on their trading volume, forex pairs are grouped into three categories:
Major pairs – these are the most traded currency pairs in terms of volume and typically contain the US dollar traded against other strong currencies like the EUR, JPY, GBP, CHF, AUD, CAD, and NZD. These eight currencies combine to form seven major currency pairs, namely EUR/USD, USD/JPY, GBP/USD, AUD/USD, USD/CHF, USD/CAD, and NZD/USD.
Crosses (or Minors) – these forex pairs contain the currencies of highly developed economies but do not include the USD. Popular examples include EUR/JPY, EUR/GBP and EUR/CHF.
Exotics – these forex pairs consist of currencies with lower trading volume, most of which are paired with the USD but not necessarily so. Some examples are USD/TRY, USD/MXN and USD/HKD.
As we can see in the table below, according to the Bank of International Settlements, currencies such as the Chinese yuan (CNY) and the Hong Kong dollar (HKD) have become increasingly popular in recent years. They are now widely traded and rival some of the major currencies in terms of volume. It is also interesting to see that NZD/USD is the only major forex pair to have seen its trading volume decline over the 2022 triennial survey period.
Using data from the triennial survey carried out by the Bank of International Settlements, we composed a table of the daily trading volumes of the most popular currency pairs and how they have changed from 2019 to 2022.
| Forex pair | 2019
| 2022
| Change in Trading Volume from 2019 to 2022 | ||
|---|---|---|---|---|---|
| All currency pairs | $6,590bn | $7,508bn | |||
| EUR/USD | $1,584bn | 24.00% | $1,706bn | 22.70% | 7.70% |
| USD/JPY | $871bn | 13.20% | $1,014bn | 13.50% | 16.4% |
| GBP/USD | $630bn | 9.60% | $714bn | 9.50% | 13.3% |
| AUD/USD | $358bn | 5.40% | $381bn | 5.10% | 6.4% |
| USD/CAD | $287bn | 4.40% | $410bn | 5.50% | 42.9% |
| USD/CHF | $228bn | 3.40% | $293bn | 3.90% | 28.5% |
| NZD/USD | $107bn | 1.60% | $99bn | 1.30% | -7.5% |
| Total Majors | $4,065bn | 61.70% | $4,617bn | 61.50% | 13.6% |
| USD/CNY | $269bn | 4.10% | $495bn | 6.60% | 84% |
| USD/HKD | $233bn | 3.30% | $178bn | 2.40% | -23.6% |
| EUR/GBP | $131bn | 2.00% | $154bn | 2.00% | 17.6% |
| USD/KRW | $125bn | 1.90% | $128bn | 1.70% | 2.4% |
| EUR/JPY | $114bn | 1.70% | $103bn | 1.40% | -9.6% |
| USD/INR | $110bn | 1.70% | $118bn | 1.60% | 7.3% |
| USD/SGD | $110bn | 1.70% | $170bn | 2.30% | 54.5% |
| USD/MXN | $105bn | 1.50% | $103bn | 1.40% | -1.9% |
| USD/SEK | $86bn | 1.30% | $93bn | 1.20% | 8.1% |
| USD/NOK | $73bn | 1.10% | $81bn | 1.10% | 11% |
| EUR/CHF | $73bn | 1.10% | $68bn | 0.90% | -6.8% |
| USD/BRL | $66bn | 1.00% | $63bn | 0.80% | -4.5% |
Source: Bank of International Settlements Triennial Central Bank Survey 2022
The Forex market
Forex is the largest market in the world and by a considerable margin. According to the 2022 Triennial Central Bank Survey of forex turnover conducted by the Bank of International Settlements, the forex market had a total daily global turnover of $7.5 trillion. This was a 14% increase from $6.6 trillion just three years earlier (according to data taken from the previous triennial survey in 2019).
To give you an idea of the sheer size of the forex market, we can compare it to the size of the global equities market. While the stock market has a longer history than forex, the latter has grown exponentially, surpassing all other financial markets. The overall value of the forex market reached a whooping $2.74 quadrillion in 2022.
Forex Markets – Who are the players?
Forex is a truly global and decentralized over-the-counter (OTC) market. Traders don’t rely on exchanges like the New York Stock Exchange or the London Stock Exchange to handle their trades. You can trade forex with anyone in the world.
The forex market encompasses central and corporate banks, non-financial companies, and individuals. Many forex transactions are done for practical purposes, such as importing a piece of machinery. Companies also use forex to hedge their exposure to foreign currency swings. However, much of the forex trading around the world is undertaken by traders (both institutional and individual) for profit purposes.
Here are the main players in the forex market:
Central banks – are an incredibly important aspect of the forex market. Central banks set interest rates that are crucial to determining the value of a given currency. Interest rate differentials between currencies are key to price movements in forex. Central banks can intervene in the forex market by buying or selling currencies, which also impacts their value.
Investment and commercial banks – the interbank market (banks trading currencies between themselves) generates the highest trading volume in the forex market. Banks will trade on behalf of clients or for themselves through their proprietary trading desks.
Money managers and hedge funds – Any financial organization running a portfolio must consider trading forex. In fact, many big companies hire professionals to trade some of the entity’s money and profit from the invested capital. When pension and life insurance funds, asset managers and hedge funds trade international portfolios they use forex to fund their purchases and hedge their portfolios.
Non-financial companies – companies that buy and sell goods from abroad also rely on the forex market. Instruments such as currency swaps are often used to hedge the risk of currency exposure.
Individuals – retail traders rely on the services of forex brokers to speculate on the price movements of currency pairs.
Here is the proportion of daily forex trading per counterparty, as estimated by the Bank of International Settlements.
| Forex Counterparties | Total (US$) | Percentage |
|---|---|---|
| Reporting Dealers | $3,462bn | 46.10% |
| Other financial institutions | $3,622bn | 48.20% |
| Non-financial customers | $425bn | 5.70% |
| Total | $7,508bn | 100% |
Source: Bank of International Settlements Triennial Central Bank Survey 2022
A few forex statistics
Here are a few statistics on forex that you might find interesting:
The US dollar (USD) is still king – the USD is a massive part of the forex market, being on one side of 88.5% of all forex trades. The euro (EUR) is the second most traded with 30.5%, followed by the Japanese yen (JPY) with 16.7% and the British pound (GBP) with 12.9%.
EUR/USD is the most traded pair, accounting for 22.7% of the total forex trading volume – This is followed by USD/JPY with 13.5% and then GBP/USD with 9.5%.
Individual forex trading (both retail and professional) is still a small fish in a big pond – The importance of retail forex (non-financial customers) trading remains relatively small as this segment accounts for just 6% of the market’s total global turnover.
Here are the top 20 most traded currencies on one side of a forex trade:
| Currency | Code | Daily Volume | Proportion |
|---|---|---|---|
| MAJOR CURRENCIES | |||
| US dollar | USD | $6,639bn | 88.50% |
| Euro | EUR | $2,292 bn | 30.50% |
| Japanese yen | JPY | $1,253 bn | 16.70% |
| British pound | GBP | $968bn | 12.90% |
| Australian dollar | AUD | $479bn | 6.40% |
| Canadian dollar | CAD | $466bn | 6.20% |
| Swiss franc | CHF | $390bn | 5.20% |
| New Zealand dollar | NZD | $125bn | 1.70% |
| OTHERS | |||
| Chinese yuan | CNY | $526bn | 7.00% |
| Hong Kong dollar | HKD | $194bn | 2.60% |
| Swedish krona | SEK | $168bn | 2.20% |
| Korean won | KRW | $142bn | 1.90% |
| Singapore dollar | SGD | $182bn | 2.40% |
| Norwegian krone | NOK | $125bn | 1.70% |
| Mexican peso | MXN | $114bn | 1.50% |
| Indian rupee | INR | $122bn | 1.60% |
| Russian ruble | RUB | $14bn | 0.00% |
| South African rand | ZAR | $73bn | 1.00% |
| Turkish lira | TRY | $27bn | 0.00% |
| Brazilian real | BRL | $66bn | 1.00% |
| Total | $7,506bn | 100.00% | |
Source: Bank of International Settlements Triennial Central Bank Survey 2022
Forex – a 24 hours per day market, 5 days per week
The forex market is a truly global market and forex never sleeps (weekends are the only exception). It operates 24 hours a day, five days a week.
The main trading hubs are London, New York, Sydney and Tokyo. So, no matter what time of the weekday it is or where you are in the world, the forex markets are open. If you are living in Europe, the forex market opens late on Sunday evening (from 10 pm GMT when the markets in Asia and Australasia open) and remains open until Friday evening (around 10 pm GMT when the US session ends).
However, since the time zones of Australia and Japan are relatively close, the two countries are grouped into a single Asian session. This also means that the Asian session is effectively longer than the others. Markets open as traders in New Zealand take to their desks in the morning, three hours ahead of Tokyo, whilst traders in China and India are also still in bed.
All this gives rise to the three-session system of forex trading. Here are the times for the three global sessions:
| Session | Main hub | Duration of Session |
|---|---|---|
| European session | London | 8 am GMT / 5 pm GMT |
| North American session | New York | 1 pm GMT / 10 pm GMT |
| Asian session | Sydney / Tokyo | 12 am GMT / 9 am GMT |
Watching the volatility during the session overlaps
Looking at the operating times of the three sessions, we see some overlaps. As more traders are active in the markets during these overlaps, these periods are characterized by elevated volumes and subsequently higher volatility.
As the Asian session is coming to an end and the European session takes hold, there is an overlap of around 1 hour 7 am GMT/8 am GMT.
Moving into the European afternoon, US traders are just getting to their desks with their morning coffee. This leaves around 4 hours between 12 pm GMT and 4 pm GMT when US and European traders are all active at the same time.
There is also a window of decreased trading volume to be aware of. As the US session winds down around 8 pm GMT/9 pm GMT, it takes a few hours for Asian traders to get stuck into the session. There is a five-hour time difference between the west coast of North America and New Zealand, and that is before Tokyo gets going too.
Below we see a volume chart for EUR/USD (the most widely traded forex pair) across 24 hours. We can see the spikes in volume around the session overlaps, but also the lull in volume as the US session hands over to Asia.
We can also see the highest volume in forex trading occurs during the European afternoon, for the overlap between the European and North American sessions.
Forex speculation
We will now take you through all you need to know about speculating on the forex market, in other words, forex trading.
A simple forex trade
If a trader buys EUR/USD when it is trading at $1.2000, it would cost them $1.20 to buy €1. If the price moves higher to $1.2500 and the trader decides to sell (i.e. close) that position then selling that €1 would generate $1.25. The round trip of the trade has generated a profit of $0.05.
Speculators trade forex on the expectation that forex prices will either rise or fall. You can buy (go long) or sell (go short) a currency pair.
If you believe that the EUR will strengthen in value relative to the USD, you would buy (or go long) EUR/USD. If you believed that the EUR would weaken relative to the USD, then you would look to sell (or go short) EUR/USD.
A forex quote
Here is a real quote for EUR/USD taken from the MetaTrader 4 trading platform.
Here it costs $1.18196 to buy €1 (or 1.18196 US dollars to buy 1 euro). However, you will also note that the two prices make up a quote.
What is the spread?
The two prices that make up a forex quote are the “bid price” (in this case, the price you buy euros at) and the “ask price” (the price you sell euros at).
- The bid price is always the higher price, in this instance 1.18196.
- The ask price is always the lower price, here 1.18185. This is also sometimes referred to as the “offer” price.
The difference between the Bid and Ask prices is known as the “spread”. This is how forex brokers/dealers make their money. On this quote, the spread is 0.00011 or 1.1 pips. But what does this mean?
What is a pip?
Forex quotes are measured in pips. A pip means a “percentage in point”. In the vast majority of forex quotes, a pip is a single-digit movement in the 4th decimal place of a currency pair.
If the EUR/USD price moves from $1.1853 to $1.1857 then the pair has moved up by 4 pips.
Many forex brokers will quote their prices to one-tenth of a pip, adding a fifth decimal place to the price. This is because they have variable spreads in their quotes. For example, the price of EUR/USD may move from $1.18376 to $1.18293. This would be a fall of 8.3 pips.
However, there is a big exception to this rule, and that comes when you are trading the Japanese yen. When you are trading yen crosses, a change of 1 pip occurs in the second decimal place. For example, if the USD/JPY price moves from 110.52 to 110.57, this would be an increase of 5 pips.
The use of leverage
Compared to other markets you can trade, forex pairs do not move as much. It is not uncommon for cryptocurrencies or stocks to move up or down by 10% in a day. However, if a forex pair moves by more than 1% or 2% in a day, this is considered a big move. If EUR/USD moved by 10% in one day, it would probably mean that the world as we know it was coming to an end and this dramatic price fluctuation will cause absolute pandemonium across the financial markets.
So if forex pairs don’t move much, how can you make decent money by trading them? The answer is through leverage.
Lots
On a standard trading account, forex trading positions are measured in “lots”, where 1 lot is equal to 100,000 units of the base currency.
If you buy 1 lot of EUR/USD at $1.1850, then you are effectively trading with $118,500. This would mean that a 1-pip move (remember, the fourth decimal place in the price) would equate to a $10 change in the position.
Therefore on your 1 lot of EUR/USD that you bought at $1.1850, if the price increased by 22 pips for you to close the position at $1.1872, the total position would now be worth $118,720. The profit on the trade would be $220.
Margin & Leverage
Without leverage, most forex traders would not have the capital available to be able to trade 100,000 units of a base currency. Trading on leverage gives you much greater exposure to the forex market. The amount of leverage available to traders depends on the regulatory jurisdiction in which they are trading, however, leverage can be available from thirty times (1:30 in European jurisdictions) up to several hundreds of times (in jurisdictions like Mauritius, Vanuatu or the Bahamas).
Leverage of 1:30 means that a trader needs a 3.33% margin in their account. For a $100,000 position, a trader would need just $3,300 deposited in their balance.
The risk of trading forex on margin
However, trading in a larger size comes with a much higher risk. As we said earlier, trading 1 Lot (100,000 units of the base currency) means that every movement of 1 in EUR/USD is worth $10.
Although forex pairs may not move much in percentage terms, when using leverage, a 40/50 pip swing in the price can take a matter of minutes. Unless you trade forex using adequate protection for your positions (such as stop-losses) you can blow up your account very quickly.
Different forms of forex trading
There are several ways to trade forex and we will help you differentiate between them. You can engage in spot forex trading (buying and selling the underlying currency), or trade derivatives (using contracts to speculate on currency price movements). There are several elements to these that we will now explain.
Spot forex – Spot trading is the primary market for forex trading. Big banks tend to be among the main actors in this market and this is where we get the term “interbank market” from. Institutional traders will trade between themselves to take delivery between two counterparties, using a T+2 delivery (i.e. Today + 2 days).
Individual traders (the retail trader) – Such people enter the forex market by using a broker, effectively via a secondary market. The broker acts as an intermediary between the individual trader and counterparties such as big banks. The bigger players provide brokers with liquidity for their clients (individual traders) to use. Brokers offer individuals the ability to trade on margin where traders can leverage their accounts to many times their original size. However, trading on margin significantly increases the level of risk for the trader.
Forex Forwards and Futures – Forwards are private contracts between two counterparties to exchange a currency at a future date at a predetermined price. Futures are standard contracts to take delivery of a currency at a future date and predetermined price. The big difference between the two is that forwards are off-exchange agreements, whereas futures are traded on public commodities markets.
Forex Options – Trading forex options gives you the right, but not the obligation to buy and sell forex on a specific date in the future at a specified price. Options trading in forex is similar to futures trading. The difference is that futures contracts have the obligation for delivery, but there is no such obligation with options.
Forex Swaps – Swaps are agreements to exchange interest payments between two foreign parties at fixed dates throughout the life of the contract. Currency swaps are used as a long-term tool to hedge the currency risk of long-term foreign investments. Companies can use swaps to gain more favorable loan rates in a foreign currency than they would get from borrowing money abroad.
This table lays out the level and proportion of daily volumes of the various forex trading instruments.
| FX Instruments | Total (US$) | Percentage of Total Forex Volume |
|---|---|---|
| Spot | $2,107bn | 28.10% |
| Outright forwards | $1,163bn | 15.50% |
| FX Swaps | $3,810bn | 50.70% |
| Currency Swaps | $124bn | 1.70% |
| FX Options | $304bn | 4.10% |
| Total market | $7,508bn | 100.00% |
Source: Bank of International Settlements Triennial Central Bank Survey 2022
How to be a forex trader?
Now let’s take you through the steps of becoming a forex trader:
Learn your trade – Read around the subject of forex trading. It is always best to understand what you are getting into. Before you take the plunge into forex trading, you should learn all about spreads, leverage, volatility, and how forex markets move. This will give you a base to develop your skills.
Set up an account with a forex broker – do your research into which broker fits your priorities. Some will be good on fees, some will help you with trading ideas, some will be good in terms of customer service. Think about what is important for you. Websites such as BestBrokers.com can help.
Develop a trading strategy – trading with a scattergun approach is not going to be profitable for you in the long run. Spend time developing trading ideas and contemplating your positions and exit strategies. This will give you the biggest opportunity for success. Additionally, we recommend learning how to use a trading platform too. This will help you avoid making costly elementary mistakes.
Self-reflection – going into forex trading without any preparation is the quickest way to lose money. Trading can be an emotional rollercoaster and you need to make informed decisions based on trends, analysis, and critical thinking. If you can understand why you make decisions, then you can learn from your mistakes and, hopefully, correct them.
Stay on top of current events – Markets are constantly changing direction. Know your markets, and know what makes them tick. Keeping on top of current market-moving events will allow you to alter your positioning as markets swing around.
What is a forex broker?
It is possible to take your dollars or euros to the local foreign exchange bureau to buy and sell other currencies. Although this is a form of forex trading, you will get terrible exchange rates and find your funds are quickly diminishing as a result.
Fortunately, there is an easier way for individuals to enter the forex market and have the opportunity to make a profit. However, they need a little assistance. Traders would need an intermediary to connect them to the market. This intermediary is a foreign exchange trading provider, also called a forex broker.
A broker will provide a trader with a trading platform and access to the forex market. The trader can then speculate on the movements in the forex market. The broker can also provide the trader with leverage for their account, giving greater levels of exposure and the ability to make greater profits. The broker executes the trades for the trader, in exchange for a fee (generated through the spread, commissions, or both).
Different Styles of Forex trading
There are many different ways in which traders can dip their toes into the forex market. Some look to trade with an extremely short-term outlook, whilst others like to play the long game.
Let’s take a look at the various methods you could employ.
| Trading style | How often do you trade | Length of time holding a position | Idea generation |
|---|---|---|---|
| Scalping | Many per day – Positions opened and closed very quickly | A few seconds to minutes | Short-Term Technical Analysis |
| Day trading | Several per day | Several minutes to hours | Data / Newsflow / Technical Analysis |
| Swing trading | Several per week | A few days | Technical Analysis |
| Trend chasing | Several per month | A few weeks | Technical analysis |
| Position trading | A few per year | Months, maybe years | Fundamentals |
What moves the forex markets?
Forex markets move around, driven by a multitude of factors. The outlook for one currency relative to another is a crucial aspect of how forex crosses move. Understanding the factors that cause price fluctuations and predicting these moves can be the difference between success and failure.
Here are some of the main factors that move the markets:
The outlook for interest rates – to prevent an economy from either overheating or undercooking, central banks will adjust the level of interest rates to manage the economy. Forex markets move on the speculation of the next move that central banks will make or the long-term path of interest rates in the future. Bond yields are the primary reflection of this, with forex rates reacting in accordance with bond markets.
Newsflow – newsflow on political events (such as changes of government), economic data (such as inflation, growth or unemployment) and naturally occurring events (such as natural disasters) can all impact the price of a currency and its relative valuation measured against other currencies.
Sentiment – market forces, momentum and sentiment are all important aspects of how forex moves. Traders use analytical tools such as fundamental analysis and technical analysis to predict how markets will move.
Pros and Cons of forex trading
Before you start trading forex, there are a few factors you might want to consider. There are many reasons why forex trading is so popular among retail traders. However, trading forex also comes with some risks.
Here are a few pros and cons of forex trading:
Key Pros
- Trade forex 24 hours per day, five days a week – markets are open every hour, Monday to Friday. This allows traders to trade markets when they want, day or night.
- Go long or short – when trading forex, you can speculate on the price moving higher or lower. Whichever way you think the market direction is headed, you can profit. It’s your call.
- Lower fees – Trading in equities, bonds and funds (such as ETFs and mutual funds) will often incur extra fees and commissions, possibly even on top of the spreads charged. If you do your research and pick the right broker, trading forex can be an asset class that keeps your trading costs much lower than other assets. Commissions and extra fees are not typically a feature of trading forex (unless you choose a zero-spread account that specifically does this to reduce costs even further).
- Forex markets are highly liquid – the huge number of market participants enables tight spreads and reduced gapping. Tight spreads on markets help keep the costs of trading low. With forex, you are trading in a truly global market, meaning that with so many participants, this reduces the potential for slippage and gaps when orders are being filled.
- Trade forex on margin – gives you the exposure to make bigger profits. Brokers tend to offer higher margin levels on forex instruments. With the high levels of liquidity and fast-moving markets, trading forex on margin enables traders to generate returns faster.
Key Cons
- Margin trading can be just as risky as it is beneficial. Margin trading in combination with highly volatile markets means that high leverage can lead to bigger and quicker losses.
- Overnight financing charges – arguably the hidden costs of forex trading. Traders are often (but not always) charged just for holding positions open overnight. This is in contrast to investing in equities or bonds which have no financing charges and periodically pay a yield (either dividends or interest) for holding the asset.
- The disadvantage of being a small fish in a big pond – forex markets are dominated by the big banks who have access to state-of-the-art technology, research and can influence prices with their positions. Forex retail traders can feel like they are being buffeted around by the bigger players in the game. However, just because the banks are bigger, it does not mean they are always right.
Conclusion
Forex trading is an extremely popular form of investment. Due to the availability of margin, successful forex traders can achieve anything from a nice profitable pastime to making a lucrative living.
In this guide, we explained what forex is and how the forex market works. We also described how to start your journey into forex trading. As we have also tried to explain, the most important aspect to remember is to do your research and go into it with your eyes wide open.
Good luck with your forex trading, everyone!
