What is forex and how does it work?
Take a closer look at everything you’ll need to know about forex, including what it is, how you trade it and how leverage in forex works.
Interested in forex trading with us?
Start trading today. Call +44 (20) 7633 5430, or email sales.en@ig.com to talk about opening a trading account. We’re here 24/5.
Contact us: +44 (20) 7633 5430
Start trading today. Call +44 (20) 7633 5430, or email sales.en@ig.com to talk about opening a trading account. We’re here 24/5.
Contact us: +44 (20) 7633 5430
Written by Anzél Killian, Senior Financial Writer. Reviewed by Axel Rudolph, Senior Market Analyst
What is forex trading?
Forex trading, also known as foreign exchange or FX trading, is the conversion of one currency into another. FX is one of the most actively traded markets in the world, with individuals, companies and banks carrying out around $6.6 trillion worth of forex transactions every single day.
While a lot of foreign exchange is done for practical purposes, the vast majority of currency conversion is undertaken by forex traders to earn a profit. The amount of currency converted every day can make price movements of some currencies extremely volatile – which is something to be aware of before you start forex trading.
We’re one of the world leading retail forex providers7 – with a range of major, minor and exotic currency pairs for you to go long or short on.
Ready to start trading forex? Open an account to get started
Beginners’ guide to forex: learn currency trading in 6 steps
Forex trading essentials for beginners
- What is a forex pair?
- What are the base and quote currencies?
- What is a pip in forex?
- What is a lot in forex trading?
What is a forex pair?
A forex pair is a combination of two currencies that are traded against each other. There are hundreds of different combinations to choose from, but some of the most popular include the euro against the US dollar (EUR/USD), the US dollar against the Japanese yen (USD/JPY) and the British pound against the US dollar (GBP/USD).
What are the base and quote currencies?
The base currency is always on the left of a currency pair, and the quote is always on the right. The base currency is always equal to one, and the quote currency is equal to the current quote price of the pair – which shows how many of the quote currency it’ll cost to buy one of the base. So, when you’re trading currency, you’re always selling one to buy another.
What is a pip in forex?
A pip in forex is usually a one-digit movement in the fourth decimal place of a currency pair. So, if GBP/USD moves from $1.35361 to $1.35371, then it has moved a single pip. But, if you’re trading JPY crosses, a pip is a change at the second decimal place. A price movement at the fifth decimal place in forex trading is known as a pipette.
What is a lot in forex trading?
Currencies are traded in lots, which are batches of currency used to standardise forex trades. As forex price movements are usually small, lots tend to be very large. For example, a standard lot is 100,000 units of the base currency.
How does forex trading work?
Forex trading works like any other transaction where you are buying one asset using a currency. In the case of forex, the market price tells a trader how much of one currency is required to purchase another. For example, the current market price of the GBP/USD currency pair shows how many US dollars it would take to buy one pound.
Each currency has its own code – which lets traders quickly identify it as part of a pair. We’ve included codes for some of the most popular currencies below.
What does it mean to buy or sell a currency pair?
To buy a currency pair means that you expect the price to rise, indicating that the base currency is strengthening relative to the quote currency. To sell a currency pair means that you expect the price to fall, which would happen if the base currency weakened against the quote.
For example, you’d ‘buy’ the GBP/USD pair if you think that the pound will strengthen against the dollar – meaning you’ll need more dollars to buy a single pound. Or, you’d ‘sell’ this pair if you think that the pound will weaken against the dollar – meaning you’ll need fewer dollars to buy a single pound.What is the spread in forex trading?
The spread in forex trading is the difference between the buy and sell prices. For example, the buy price might be 1.3428 and the sell price might be 1.3424. For your position to be profitable, you’ll need the market price to either rise above the buy price or fall below the sell price – depending on whether you’ve gone long or short.
What are margin and leverage in FX trading?
Margin refers to the initial deposit you need to commit in order to open and maintain a leveraged position. So, a trade on EUR/USD might only require a 0.50% margin in order for it to be opened. As a result, instead of needing $100,000 to open a position, you’d only need to deposit $500.
Why do people trade forex?
Taking a position on currencies strengthening or weakening
Traders make a prediction on forex pairs to profit from one currency strengthening or weakening against another. When the price of a pair is rising, it means that the base is strengthening against the quote and when it’s falling, the base is weakening against the quote.
That’s because a rising price means that more of the quote are needed to buy a single unit of the base, and a falling price means that fewer of the quote are needed to buy one of the base. So, traders would likely go long if the base is strengthening relative to the quote currency, or short if the base is weakening.
Some of the most popular forex trading styles are scalping, day trading, swing trading and position trading. You might choose a different style depending on whether you have a short- or long-term outlook.
Hedging with forex
Hedging is a way to mitigate your exposure to risk. It’s achieved by opening positions that will stand to profit if some of your other positions decline in value – with the gains hopefully offsetting at least a portion of the losses. Currency correlations are effective ways to hedge forex exposure. An example would be EUR/USD and GBP/USD, which are positively correlated because they tend to move in the same direction. So, you could go short on GBP/USD if you had a long EUR/USD position to hedge against potential market declines.
Seize opportunity 24 hours a day
The forex market is open 24 hours a day thanks to the global network of banks and market makers that are constantly exchanging currency. The main sessions are the US, Europe and Asia, and it’s the time differences between these locations that enables the forex market to be open 24 hours a day.
The forex trading market hours are incredibly attractive, offering you the ability to seize opportunity around the clock. We are also the only provider to offer weekend trading on certain currency pairs, including weekend GBP/USD, EUR/USD and USD/JPY. That means you can trade these combinations when others can’t.
Learn how currency markets work
What moves the forex market?
The forex market is made up of currencies from all over the world, which can make exchange rate predictions difficult as there are many forces that can contribute to price movements. That said, the following factors can all have an effect on the forex market.
Central banks
A currency’s supply is controlled by central banks, who can announce measures that will have a significant effect on that currency’s price. Quantitative easing, for example, involves injecting more money into an economy, and can cause a currency’s price to fall in line with an increased supply.
News reports
Commercial banks and other investors tend to want to put their capital into economies that have a strong outlook. So, if a positive piece of news hits the markets about a certain region, it will encourage investment and increase demand for that region’s currency. If negative news hits, then demand might be expected to fall. This is why currencies tend to reflect the reported economic health of the region they represent.
Market sentiment
Market sentiment, which often reacts to the news, can also play a major role in driving currency prices. If traders believe that a currency is headed in a certain direction, they will trade accordingly and may convince others to follow suit, increasing or decreasing demand.
How to become a forex trader
Learn the ways to trade forex
There are several ways to trade forex, including trading spot forex, forex futures and currency options. When you trade with us, you’ll be predicting on the price of spot forex, futures and options either rising or falling with a CFD account.
- Spot forex trading lets you trade forex pairs at their current market price with no fixed expiries
- Forex or currency futures enable you to trade forex pairs at a specified price to be settled at a set date in the future or within a range of future dates
- Forex or currency options let you trade contracts that give the holder the right, but not the obligation, to buy or sell a currency pair at a set price, if it moves beyond that price within a set time frame
All of these – spot, futures and options – can be traded with and FX CFDs. These are financial derivatives which let you predict on whether prices will rise or fall without having to own the underlying asset.
What is a forex broker?
A forex broker provides access to trading platforms that can be used to buy and sell currencies. For example, when you trade forex with us, you’ll be able to use our award-winning platform8 or MT4 – both of which have their own unique benefits.
Forex brokers charge a fee, usually in the form of a spread. This is the difference between the buy (offer) and sell (bid) prices, which are wrapped around the underlying market price. The costs for a trade are factored into these two prices, so you’ll always buy slightly higher than the market price and sell slightly below it.
Traditionally, a forex broker would buy and sell currencies on behalf of their clients or retail traders. But, with the rise of online trading, you can buy and sell currencies yourself with financial derivatives like CFDs, so long as you have access to a trading platform. This is because all forex trades are conducted over-the-counter (OTC), rather than on exchange like stocks.
Discover the risks and rewards of trading forex
- Forex is the most-traded financial market in the world, which means that forex prices are constantly moving, creating more opportunities to trade
- Some forex pairs are more volatile than others. Those with low liquidity are often more volatile, including many ‘minor’ pairs
- Pairs that include USD are often more liquid because as the world’s reserve currency, USD is often in high demand
- Slippage is sometimes an issue in forex trading, given how volatile the market can be. To help mitigate the effects of slippage on your forex trades, you should add stops and limits
- But, if you are aware of the risks and take appropriate steps to mitigate your exposure, then the forex market can be the source of your next opportunity
Free forex trading courses and webinars
To succeed when trading forex, you’ll need to take advantage of educational resources and platforms to help you build your confidence. We offer both: IG Academy and our demo account.
IG Academy has a wealth of information to get you acquainted with the markets and learn the skills needed for boosting your chances of trading forex successfully. Alternatively, you can use an IG demo account to build your trading confidence in a risk-free environment, complete with $20,000 in virtual funds to plan, place and monitor your trades.
We also offer trading strategy and news articles for all experience levels. This includes ‘novice’, like how to be a successful day trader, up to ‘expert’ – looking at technical indicators that you’ve perhaps never heard of.
Once you’ve built your confidence and feel like you’re ready to trade the live forex markets, you can create a live account with us in five minutes or less. You’ll get access to award-winning platforms,8 expert support around the clock and spreads from just 0.6 points.
FAQs
What does forex (FX) trading mean?
Forex trading means exchanging one currency for another. Forex is always traded in pairs which means that you’re selling one to buy another.
Is there a difference between forex trading and currency trading?
There is no difference between forex trading and currency trading, as both mean that you’re exchanging one currency for another. When forex trading or currency trading, you’re attempting to earn a profit by predicting on whether the price of a currency pair will rise or fall.
How can I make money from forex trading?
You can make money from forex trading by correctly predicting a currency pair’s price movements and opening a position that stands to profit. For example, if you think that a pair will decline in value, you could go short and profit from a market falling.
Alternatively, if you think a pair will increase in value, you can go long and profit from an increasing market.
How can I get started trading FX?
You can get started trading FX with a forex trading account. Plus, you’ll also need to be familiar with what moves the forex market – like central bank announcements, news reports and market sentiment – and take steps to manage your risk accordingly.
What costs and fees do you have to pay when currency trading?
The costs and fees you pay when trading currency will vary from broker to broker. But, you should bear in mind that you’ll often be trading currency with leverage, which will reduce the initial amount of money that you’ll need to open a position. Be aware though that leverage can increase both your profits and your losses.
How much money is traded on the forex market daily?
Approximately $6.6 trillion worth of forex transactions take place daily, which is an average of $250 billion per hour. The market is largely made up of institutions, corporations, governments and currency speculators – speculation makes up roughly 90% of trading volume and a large majority of this is concentrated on the US dollar, euro and yen.
Is forex trading income taxable?
The tax on forex positions does depend on which financial product you are using to trade the markets.
When you trade via a forex broker or through CFDs, any gains to your forex positions are taxable. However, your losses are tax-deductible, and depending on your circumstances can also be used to offset gains made elsewhere.9
How is the forex market regulated?
Despite the enormous size of the forex market, there is very little regulation because there is no governing body to police it 24/7. Instead, there are several national trading bodies around the world who supervise domestic forex trading, as well as other markets, to ensure that all forex providers adhere to certain standards. For example, in the UK the regulatory body is the Financial Conduct Authority (FCA).
What are gaps in forex trading?
Gaps are points in a market when there is a sharp movement up or down with little or no trading in between, resulting in a ‘gap’ in the normal price pattern. Gaps do occur in the forex market, but they are significantly less common than in other markets because it is traded 24 hours a day, five days a week.
However, gapping can occur when economic data is released that comes as a surprise to markets, or when trading resumes after the weekend or a holiday. Although the forex market is closed to speculative trading over the weekend, the market is still open to central banks and related organisations. So, it is possible that the opening price on a Sunday evening will be different from the closing price on the previous Friday night – resulting in a gap.
Develop your forex knowledge with IG
Find out more about forex trading and test yourself with IG Academy’s range of online courses.
Try these next
Take a look at our list of financial terms that can help you understand trading and the markets
Be aware of the risks associated with forex trading and understand how IG supports you in managing them
Discover the different platforms that you can trade forex with IG
1 Bank of International Settlements Triannual Survey, 2019
2 Calculated using figures from the IMF, 2019
3 Calculated using the initial contract value for 15 October 2008
4 Calculated using data from Coin Market Cap
5 Calculated using Office of National Statistics average weekly earnings from Q3 2020
6 Calculated using a Forbes estimate of Jeff Bezos’s net worth, October 2020
7 By number of primary relationships with FX traders (Investment Trends UK Leveraged Trading Report released June 2021).
8 Best Finance App, Best Multi-Platform Provider and Best Platform for the Active Trader as awarded at the ADVFN International Financial Awards 2024.
9 Tax laws are subject to change and depend on individual circumstances. Tax law may differ in a jurisdiction other than the UK.
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