What is forex (FX) trading?

FX trading, also known as foreign exchange trading or forex trading is the exchange of different currencies on a decentralised global market. It’s the largest and most liquid financial market in the world. Open a free demo account to practice trading on foreign exchange rates with $10,000 in virtual funds, risk-free. Currency trading is available through CFDs on our platform.

Foreign exchange rates between different currency pairs show the rates at which one currency will be exchanged for another. It plays a vital role in foreign trade and business as products or services bought in a foreign country must be paid for using that country's currency.

Discover more about different currencies and the strongest currencies in the world.

What is forex trading and how does it work?

Foreign exchange trading is also known as FX trading or forex trading. It provides the opportunity to speculate on price fluctuations within the FX market. The goal of FX trading is to forecast if one currency’s value will strengthen or weaken relative to another currency.

A forex trader will encounter several trading opportunities each day, due to daily news releases. They take advantage of this by becoming extremely receptive to market news releases and then trade based upon the suspected market sentiment. FX is an industry term that is abbreviated from forex, and is commonly used instead of forex. However, forex is also an abbreviation of foreign exchange. Read more about forex news trading strategy.

Forex is always traded in currency pairs – for example, USD/CAD (US dollar v Canadian dollar).

Forex trading works by speculating against the difference in valuation of two currencies. For example, If you were to trade the USD/CAD, and thought the price of the CAD dollar were to drop lower than USD, you could short sell the currency pair to profit from the difference in value.

Looking at the USD/CAD currency pair, the first currency (USD) is called the 'base currency' and the second currency (CAD) is known as the 'counter currency'. Alternatively, if you think USD will fall against CAD (or that CAD will rise against USD), you could go long.

The foreign exchange market

The foreign exchange is one of the most widely traded markets in the world, with a total daily average turnover reported to exceed $5 trillion a day. The forex market is not based in a central location or exchange, and is open 24 hours a day from Sunday night through to Friday night. A wide range of currencies are constantly being exchanged as individuals, companies and organisations conduct global business and attempt to take advantage of rate fluctuations.

The foreign exchange market is used primarily by central banks, retail banks, corporations and retail traders. Understanding how each of these players interact with the FX market can help to determine market trends as part of your fundamental analysis.

Central banks are responsible for managing their nation’s currency, money supply and interest rates. When action is taken by central banks, it is usually to stabilise the nation’s currency.
Retail banks trade large volumes of currency on the interbank market. Banks exchange currencies between each other on behalf of large organisations, and also on behalf of their accounts.
Corporations that have dealt with companies overseas have to take part in the foreign exchange market to transfer funds for imports, exports or services.
Retail traders account for a much lower volume of forex transactions in comparison to banks and organisations. Using both technical analysis and fundamental analysis, retail traders aim to profit from forex market fluctuations.

What is leverage in forex trading?

When trading, forex leverage allows traders to control a larger exposure with less of their own funds. The difference between the total trade value and the trader’s margin requirement is usually ‘borrowed’ from the forex broker. Traders can usually get more leverage on forex than other financial instruments, meaning they can control a larger sum of money with a smaller deposit. While your potential profit is maximized, so is your potential loss.

Since forex is traded on margin, you only have to deposit a percentage of the full amount you wish to trade. Our margins start from 2.9%, which could be referred to as 34:1 leverage, as the value of the full position would be 34 times the value of the deposit required to open the trade. When trading on margin it's important to remember that your profits or losses are based on the full value of the position, not just the percentage you deposited, so you can lose more than your initial deposit.

What is spread in forex?

The spread in forex trading is the difference between the buy and sell price of an FX currency pair. When you trade forex pairs, you are presented with a ‘buy’ price that is often above the market price and a ‘sell’ price that is often below the market price. The difference between these two prices is referred to as the ‘bid-ask’, or ‘buy-sell’ spread.

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How to trade the FX market

There are a many ways to trade on the forex market, all of which follow the previously mentioned principle of simultaneously buying and selling currencies. If you believe an FX ‘base currency’ will rise relative to the price of the ‘counter currency’, you may wish to ‘go long’ (buy) that currency pair. If you believe the opposite will happen and the market will fall, you may wish to ‘go short’ (sell) the currency pair. To help you understand how forex trading works, you may find it useful to view some of our forex CFD examples.

The forex market was historically traded via a forex broker. However, with the rise of online trading companies, you can take a position on forex price movements with an MT4 or our proprietory Next Generation CFD trading account. Both the MT4 and Next Generation CFD trading accounts provide a form of derivative FX trading where you do not own the underlying asset, but rather speculate on its price movements. Derivative trading can provide opportunities to trade forex with leverage.

Read our guide on forex trading strategies.

Forex trading strategies

Forex traders use FX trading strategies to guide their buying and selling activities, whether it be from an office or trading at home as a hobby. The ability to follow a strategy that informs a trader’s decisions is what differentiates trading from guesswork. Many traders create strategies by adopting elements from others’ trading strategies, but tailor the systems to meet their own specific needs.

A currency trading strategy often includes a number of forex signals and technical indicators. A forex trading signal can provide prompts to help determine entry and exit points for a given forex market. These signals can be determined by either manual or automated methods. Manual methods involve looking at chart patterns and averages to determine buy and sell opportunities. Automated methods use algorithms that determine trading signals and execute trades based on several pre-set conditions. Forex scalping can use either of these methods, where the aim of the trader is to enter and exit the market as quickly as possible, with the aim of making small but frequent profits.

You can use numerous trading strategies to inform your trading decisions. Forex trading strategies, like other trading strategies, can be based on a combination of technical analysis and fundamental analysis. Technical and fundamental analysis are very different, so a blend of the two can be used to develop a more balanced trading strategy.

Many popular forex trading strategies, such as those outlined in our forex trading strategies guide, are based on trading chart patterns and mathematical formulas. Bear in mind that our forex strategies guide is not a definitive list, and just outlines some popular technical methods some experienced traders use. Other traders will trade based on macroeconomic forex news. This ‘big picture’ news tends to influence forex markets to a greater degree than any other factors. For example, news that suggests rising interest rates without a rise in inflation could increase the likelihood of a rise in currency value. By contrast, falling interest rates can increase the ease and likelihood of lending, but can devalue a nation’s currency in the long-term.

What is a forex chart?

Forex charts are price charts that show the current and past price of currency pairs. The aim of a price chart is for investors to see price actions over various time frames and use technical and fundamental analysis, combined with indicators to find patterns which can assist trading decisions.

What influences the foreign exchange markets?

To trade the forex market with little awareness of the factors that influence the FX market can result in substantial losses. Many of the macroeconomic forces at play can have huge effects on the valuation of a currency.

When looking at forex markets, it's important to remember that a stronger currency makes a country's exports more expensive for other countries, while making imports cheaper. A weaker currency makes exports cheaper and imports more expensive, so foreign exchange rates play a significant part in determining the trading relationship between two countries.

Political instability and economic performance

Political instability and poor economic performance can also influence the value of a currency, such as when there are presidential elections and national recessions. Politically stable countries with robust economic performance will usually be more appealing to foreign investors, so these countries draw investment away from countries characterised by more economic or political risk.

Furthermore, a country showing a sharp decline in economic performance could see a loss of confidence and investment, as capital moves to more economically steady countries.

Interest rates

Interest rates, inflation rates and foreign currency rates are all interconnected, and as some rise others can fall. Central banks control the interest rate as a measure to control inflation. If a central bank wants to decrease inflation, it can increase interest rates in a bid to stop spending and lending. This generally increases the value of money in an economy, as there is less, or ‘more expensive’, money available in the economy.

On the other hand, when there is more money with less value in an economy, businesses and consumers increase spending and lending through loans and other types of credit. Sellers will then increase prices, causing inflation and a lower-valued currency. These fluctuations in currency value are one of the reasons forex traders may look to trade on interest rate announcements from central banks, like the US Federal Reserve or the Bank of Canada..

Inflation rates

Often paired with interest rates, inflation rates can have a major influence on a nation’s foreign exchange rates. Rising inflation rates often have a negative effect on a currency’s value. Conversely, low inflation rates usually cause an appreciation in the value of a currency. When inflation is high, the price of goods and services increases, which can cause the currency to depreciate, as there is less spending.

Terms of trade

The terms of trade for a country represent the ratio of export prices relative to import prices. If a country’s export prices rise and its import prices fall, the terms of trade have favourably improved. This increases the nation’s revenue and is followed by an increase in demand for the country’s currency. This increase in demand can cause a rise in the currency’s value.

Debts

A nation’s debt can be a large influencer in the variations of its currency price. Countries with large debts in relation to their gross domestic product (GDP) will be less attractive to foreign investors. Without foreign investments, countries can struggle to build their foreign capital, leading to higher rates of inflation and thus, currency depreciation. Read more about economic indicators that can have an effect on forex.

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What are the benefits of forex trading?

The ability to trade on forex margin (using leverage). Remember, when trading on margin, it's important to remember that your profits or losses are based on the full value of the position, not just the percentage you deposited, so you can lose more than your initial deposit. .
High levels of liquidity mean that forex spreads stay tight and trading costs stay low.
Prices react quickly to breaking news and economic announcements (this can be a disadvantage too).
Trade 24 hours a day from Sunday to Friday.
The ability to go long and short.
Wide range of markets (trade CFDs on more than 330 forex pairs with CMC Markets).

Market trends can be more predictable.

What are the potential risks of forex trading?

You can lose all of your capital - leveraged forex trading means that both profits and losses are based on the full value of the position.
Risk of account close out - market volatility and rapid changes in price can cause the balance of your account to change quickly, and if you do not have sufficient funds in your account to cover these situations, there is a risk that your positions will be automatically closed by the platform.
Currency pair correlations can increase the interest rates outside of major forex pairs.
Market volatility and gapping - financial markets may fluctuate rapidly and gapping is a risk that arises as a result of market volatility, and one of the effects of this may mean that stop-loss orders are executed at unfavourable prices.

Risk of carry trade.

Central bank decisions can have an effect on interest rate levels.

Bottom line

Forex trading is a fast-paced, exciting option and some traders will focus solely on trading this asset class. They may even choose to specialise in just a few select currency pairs, investing a lot of time in understanding the numerous economic and political factors that move those currencies.

Want to learn more about currency trading? Check out our forex trading tips guide.

FAQS

Is forex trading the same as currency trading?

Forex trading is the same as currency trading, involving the exchange of one currency for another in order to profit from the fluctuating price movements of currency pairs. Learn about the forex market in more detail.

What are margin rates for forex?

Trading on forex margin (using leverage) means that you will only have to deposit a fraction of the overall trade’s value in order to open a position. Learn more about margin in forex trading.

Can I trade on forex from home?

You can trade derivatives on forex from home using short, medium or long-term strategies on a wide range of currency pairs that we offer. Read our guide on forex trading strategies.

How many currency pairs are there in the forex market?

There are a huge number of currency pairs in the forex market, whether these are major, minor or exotic currencies. We offer forex trading on over 330 currency pairs.